Peak Oil and the Financial Markets: A Forecast for 2008--July 31 Update

Posted by Gail the Actuary on August 1, 2008 - 10:23am

Back in January, I made a financial forecast for 2008. In this post, I will update my analysis, looking both at what has happened thus far in 2008, and refining what is likely ahead.

Most forecasts are made with an overriding assumption of infinite growth, but the analysis made in January and updated now maintains an underlying assumption of resource limitations, such as will likely accompany the advent of peak oil. Under resource limitations, debtors are likely to find it difficult to pay back loans, as resources become more and more scarce. As a result, default rates are likely to continue to rise.

One of the issues I consider important in my forecast is systemic risk. This relates to the interconnectedness of the system, and predicts that if one part fails, other parts are also likely to fail. Many other articles mention this issue, but rarely address its full ramifications.

Figure 1. An example of a system with systemic risk (Photo from homebuyerphoenix.com)

I also consider the impact of systematic bias, which is different from systemic risk. Systematic bias is more closely related to the issue of resource depletion, and the fact that the infinite growth is ultimately not possible.

Lenders, and those who write insurance against loan defaults, assume that the future will be much like the past. If there is problem with loan defaults, the assumption is made that higher defaults are likely to be temporary. Models based on this assumption are faulty, because resource shortages are likely to raise the price of all types of energy products and food, year after year. This will tend to cause progressively more loan defaults, because people will have less and less money available to repay loans, after buying basic necessities.

This situation of progressively more defaults can be expected when the world is at peak oil; it can also be expected before peak oil, if energy prices rise over an extended period because the quantity of oil available is not sufficient to meet demand at a lower price. This seems to be the position we have been in recently.

Failure of financial markets to recognize the increasing risk of defaults due to resource depletion can be expected to result in a consistent underpricing of risk. Individuals and institutions owning debt-based financial products are likely to suffer huge losses, year after year, as more and more defaults occur. Insurance companies writing this risk are likely to be among the first to have problems, since their financial results are closely tied to the proper pricing of the risk charge underlying loans. Ultimately, the large number of loans which never can be paid back is likely to bring a crash to the already unstable financial system.

Background

My January forecast provides a more detailed explanation of systematic bias and systemic risk. I explain that as we approach peak oil, events that financial modelers would like to think are independent, such as defaults on loans, become much less independent. I also explain why, with systematic bias and systemic risk becoming more relevant because of resource depletion, the predictive value of financial models such as of the Capital Asset Pricing Model and the Black and Scholes Option Pricing Model is likely to decline. I also elaborate on the reasons for my forecasts.

Forecast for 2008

Let's first look at the forecast I made at the beginning of the year. Here is a point-by-point review:

1. Many monoline bond insurers will be downgraded in 2008, and some may fail.

As I noted in the introduction, insurers writing the risk of debt default are likely to be among the first with bad results. Not surprisingly, there have been many downgrades of companies writing this risk. As the year goes on, I expect to see further downgrades and financial failures. I also expect to see a ripple effect through to other financial institutions (including banks, hedge fund, pension funds, and multi-line insurance companies) because they will have to take over the risk that the monoline insurers were supposedly insuring.

Part of the impact of the failed insurers can be expected to be sudden, as banks, insurers, and other institutions fail regulatory ratios, and find themselves in need of greater capital, or need to divest themselves of certain securities which no longer meet investment standards. Part of the impact will be more gradual, as formerly insured bonds enter into default, and the lack of insurance affects the owners of the bonds. The number of defaults is likely to be much higher than in the past, because previously "safe" bonds, such as municipal bonds, will be affected by affected by falling home prices and declining tax revenues.

Mike Stathis, in the Market Oracle indicates that he considers Fannie Mae and Freddie Mac to be similar to bond insurers.

. . . much of the debt sold to institutions is guaranteed by Fannie and Freddie, making them similar to the monolines like MBIA and Ambac. Combined, they hold around $1.4 trillion in their retained portfolios and they've guaranteed over $3 trillion of what could end up being junk bonds. So you can think of Fannie and Freddie as a hybrid of bond insurers like MBIA and AMBAC, along with Washington Mutual and Countrywide.

The insurance guarantee component of Fannie and Freddie makes the situation for these companies much worse than if they were simply holders of mortgage bonds.

2. More and more people influential in financial markets will begin to recognize peak oil.

Nearly everyone is now aware that there is some kind of problem with the oil supply, and that old assumptions may not hold. For example, Business Week recently had an article in which it questioned whether Saudi Arabia could ramp up production to 12.5 million barrels a day. Even the Economist is beginning to mention peak oil, proffering an interview with Matt Simmons.

At this point, some leaders understand peak oil, but the majority is at the "peak oil lite" stage -- oil supply is short relative to demand, and the situation doesn't look like it will get much better very soon. With even this limited understanding, lenders are likely to be more cautious about granting credit, since with continued high oil prices, consumers are likely to have less money available for debt repayment. If lenders become peak oil "savvy", lending practices are likely to become even more restrictive.

3. Long term loans, including those for energy companies, are likely to become less available as awareness of peak oil rises.

The Bank for International Settlements, in its annual report, describes the world financial markets as being in turmoil, with credit availability greatly reduced.

For several years, banks were able to resell loans they initiated to third parties, using structured securities. About a year ago, the US market for structured securities, other than those guaranteed by Fannie Mae, Freddie Mac, or Ginnie Mae, started to deteriorate, as illustrated in Figure 2.

Figure 2. US Structured Securities Issued based on Table 1.4 of a report by the Securities Industry and Financial Markets Association.

Without the structured securities market, banks have become much more cautious about long term loans, such as commercial real estate loans and home mortgages that are larger than those Fannie Mae and Freddie Mac will handle.

Smaller home mortgages have continued to be reasonably available, but only because government agencies have provided a market. In the first three months of 2008, more than two-thirds of new mortgages were bought by Fannie Mae or Freddie Mac, according to the New York Times. If Ginnie Mae (providing FHA and VA loans) were included, the percentage would be even higher.

Regarding energy companies being affected by current financial disruptions, there have been articles about the collapse of SemGroup pinching small oil firms. SemGroup filed for bankruptcy after losing $2.4 billion in the oil futures market. Through its subsidiary SemCrude, it collected 541,000 barrels of oil a day from more than 2,000 independent operators in Oklahoma, Kansas, and Texas. With its failure, many of these producers have not been paid for oil already shipped. Some of the more remote producers are now being left without a market for their oil.

This example shows how financial problems can affect energy companies. While I have not seen a long-term debt example, the trend toward reduced credit almost assures that there will be energy companies that will be unable to make desired investments because of unavailability of long-term debt.

4. There is likely to be a serious recession in 2008, deepening as the year goes on.

According to the official arbiter of recession, the National Bureau of Economic Research (NBER), the US is not yet in recession. The reason they do not believe the US is in recession may partly be timing. The NBER's review is based on several measures, and some are not available immediately. Also, according to the President's Council of Economic Advisors (CEA), real GDP is not yet declining. This may reflect a mis-measurement of inflation.

The CEA's analysis uses an estimate of inflation that seem quite low--an annual rate of 2.4% in the fourth quarter of 2007 and of 2.7% in the first quarter of 2008. If the inflation rate is even a little higher than this, the country has been in a recession for some time. The reason the inflation rate is important in this calculation is because the gross domestic product is estimated first in current dollars, and then an inflation adjustment is backed out to calculate "real" gross domestic product. If the inflation adjustment is too low, it will tend to make the country look like it is not in recession, when it really is.

Whether or not the NBER says the United States is in recession, many economists believe that the United States is either in a recession now, or will soon be in a recession. When USA Today surveyed 52 economists in April 2008, it found that two-thirds felt the US is already in a recession, and 79% believed that a recession was likely by the end of the year.

I continue to believe that we are already in a recession, and the recession will get worse and worse, as the year progresses.

5. At least several large banks will fail.

At this point, IndyMac has failed, and is expected to use up as much as 15% of the funds of the FDIC. The investment bank Bear Stearns got into financial difficulty and was sold to JP Morgan Chase at a fire-sale price.

The Wall Street Journal has reported that the FDIC is staffing up for an increased number of bank failures. Estimates of the likely number of bank failures range from 90 to more than 300.

The SEC recently stated, "There now exists a substantial threat of sudden and excessive fluctuations of securities prices generally" that could affect orderly markets. Because of this risk, short sale activity is being restricted on a list of 19 large financial institutions. This list includes many very large banks, including Bank of America, Citigroup, and Deutche Bank. Some people must believe there is a risk of these institutions failing, if the price of their stocks has been dropping rapidly, and investors want to short their shares.

The Federal Reserve's survey of banks' senior loan officers, one of the most closely watched gauges of lending practices, found that the credit crunch is widening. The proportion of domestic banks tightening their standards was at or near historical highs for almost all loan categories, including credit cards and student loans.

According to that article, 55% of banks that participate in the federal student loan program are planning to reduce their lending in the fall of 2008. Banks are increasing credit score requirements and reducing available limits on credit card debt. The survey showed that 70% of banks had increased standards for home equity lines of credit in the previous three months.

7. Fannie Mae and Freddie Mac may need government assistance.

The financial problems of Fannie Mae and Freddie Mac have been in the news recently. Legislation has been passed which would establish a new regulator, and would provide a temporary rescue plan.

8. A new class of homes -- those "never to be sold" -- will emerge.

The Wall Street Journal talks about a glut of unsold homes, because of a weakening housing market. More and more homes are entering foreclosure, as owners find that their homes are no longer affordable, and the market value of the homes is less than the mortgage amount.

Foreclosed homes often sit vacant for long periods of time. Sometimes they are vandalized and stripped of their copper piping and scrap metal. Cleveland now has a grant that will allow it to renovate 50 foreclosed homes and demolish 100 others.

9. Politicians will continue to make attempts to help homeowners, and perhaps other types of borrowers.

Federal legislation under the title American Housing Rescue and Foreclosure Prevention Act of 2008 stagnated in the US congress for months, and was finally passed last week, when Fannie Mae and Freddie Mac problems became apparent, and assistance for them was added to the legislation. Prior to that, about 20 states launched foreclosure intervention or prevention initiatives.

10. The amount of structured (sliced and diced) debt issued is likely to drop to close to zero.

The amount of new structured debt sold in recent quarters, other than that guaranteed by Fannie Mae, Freddie Mac, and Ginnie Mae, has declined by more than 90%. Figure 2 is the same graph as shown above.

Figure 2. US Structured Securities Issued based on Table 1.4 of a report by the Securities Industry and Financial Markets Association.

Structured securities continue to be used for housing, but almost entirely with agency guaranteed debt. A proposal has been made in the last few days for banks to offer covered bonds as an additional option for writing mortgages. With covered bonds, investors would have recourse to banks' balance sheets, in addition to the underlying assets. It is not clear that these will be much used, because the FDIC currently restricts their use, so as to not deplete assets supporting ordinary depositors.

11. Besides banks, many other players in financial markets are likely to find themselves in financial difficulty in 2008.

One of the big issues for any organization that holds financial securities faces is how to properly value those securities. This is especially an issue for structured securities. On July 28, Merrill Lynch sold $30.6 billion of collateralized debt obligations (CDOs) for only 22 per cent of their face value. Now that this sale has been made, other organizations will have a real value to assign to similar securities, and this is likely to result in many other write-downs.

According to the Timesonline article quoted above, the Egan Jones Ratings Company (EJRC) believes that Fannie Mae and Freddie Mac will be forced into combined write-downs of $100 billion, because of this new valuation. In total, for all financial institutions, Sean Egan of EJRC believes that the write-downs related to this new valuation might total $400 billion.

Prior to the Merrill Lynch sale, American International Group, a large insurer, was in the news for its large investment losses, relating to the valuation of securities. The price of its stock has dropped 64%, and its ratings have been downgraded.

12. The value of the dollar will fall relative to some currencies, causing the relative price of oil to rise.

The value of the dollar has continued to fall relative to a trade weighted basked of currencies, while the Euro and Yen are higher.

The general trend of the stock market has been down. The Dow Jones industrial Average is down 13% since the beginning of the year; the S&P 500 index is down 14% beginning of the year. Both indexes have recently been down more than 20% from their 2007 highs, putting them into "bear territory".

14. Prices are likely to rise in 2008 for food and energy products. Prices may decline for homes and non-essential goods and services.

The price of West Texas Intermediate (WTI) crude oil is up 45% since the beginning of the year. The price of gasoline is up 35% from the beginning of the year. Recent CPI data shows US grocery prices up 6.1% relative to a year ago. Food prices around the world have been rising rapidly, and many of the poorer countries are concerned about food security.

15. There is a chance that some type of discontinuity will make financial conditions suddenly take a turn for the worse.

In my earlier article, I wrote:

Will the "wheels come off the economy"? I really don't know.

I then gave a few considerations that might prevent a serious disruption in 2008. These included the underlying momentum of the economy, the ability of regulators to change rules as they go along, the fact the congress is likely to go along with any proposed bailout plan, and the fact that much of the problem is a balance sheet problem, which it may be possible to hide for a while longer.

Since January, the events that have transpired have tended to make me more pessimistic.

One of the issues I see is that Congress is not inclined to do very much, and what it does do seems to work in the direction of increasing the deficit. Congress seems willing to pass legislation that will hand out more dollars to people (as in the stimulus legislation and the housing legislation), or raise the lending amount available to people (as in the new $625,000 cap on Fannie and Freddie loans). It does not seem to be willing to raise tax dollars to go with all of the new commitments. The higher spending coupled with the unwillingness to raise taxes can be expected to make it more difficult to fund government debt, and is likely to lead to an increase in interest rates.

A second issue is the limited nature of the various insurance funds which insure against insolvencies of banks, pension funds, and insurance companies (including FDIC, PBGC, and state insurance funds for insurance companies). These insurance funds generally have a small fund to handle insolvencies, and some mechanism for assessing solvent entities in the group if one of the members fails. In some cases, the additional funding is accomplished by increasing the insurance premiums payable in the upcoming year for the remaining solvent entities.

This funding approach works if there is only an occasional small insolvency, but not if there is an avalanche of insolvencies, all arising from the same root cause (higher oil prices, feeding through to cause higher energy and food prices, causing defaults in many areas). This means that if there is a large number of insolvencies, there will need to be some governmental approach for propping up all of these organizations, rather than just the insurance funds.

A third issue is the apparent inflexibility of our refined petroleum product pipeline distribution system. As I understand it, we need to have a certain amount of refined petroleum products in the pipelines to keep the pipelines filled. If we have too little, pipelines drop below the "minimum operating level," and we have trouble getting petroleum products to the ends of the pipelines. This is not really a remote possibility--we have already run into this problem in various parts of North America in recent years, including North Dakota, Colorado, and Canada.

It seems to me that as the amount of oil we are using decreases, our vulnerability to disruption caused by available oil dropping below the minimum operating level increases. Some possible sources of disruption include a major hurricane; the US not being able to purchase enough oil because of a drop in the value of the dollar; and OPEC refusing to sell us oil. It would seem as though such a disruption could have cascading effects--parts of the country might be left without any petroleum products (gasoline, diesel, or jet fuel) for an extended period, because all refined products are shipped in the same pipeline, with spacers in between. I don't believe that we have adequate truck and barge backup to prevent disruptions from occurring.

Looking ahead

As we go forward, I expect that there will be more and more individuals, businesses and governments that will be unable to repay their debt, because of indirect impacts of higher oil prices flowing through the economy. Eventually, the US government will have to make a decision as to what to do about all these defaults. The most obvious options would seem to be:

(1) Prop up as many as possible
(2) Let the chips fall where they may

Either of these would seem to have the potential to lead to serious disruption. If the "prop up as many as possible" approach is used, it theoretically could lead to a high inflation rate, high interest rates, and a severe drop in the dollar. I would expect imports of all kinds to drop, including petroleum imports. This could lead to parts of the country losing liquid fuels because the pipeline structure cannot easily distribute a much smaller fuel supply. The decline in imports other than oil could also be a major problem because we manufacture so little ourselves.

If a "let the chips fall where they may approach" is followed, it is possible that bankruptcies will cascade through the system. If there are inadequate funds in the FDIC, and banks are simply allowed to fail, this would have very negative consequences. One can think of a lot of other organizations that might need propping up--states with a lot of debt, like California; Fannie Mae and Freddie Mac; auto manufacturers; airlines; LNG terminals; independent oil refineries; and pension funds, to name a few.

Letting any of the major organizations fail would likely cause more homeowners to default on their mortgages and trigger yet more bankruptcies. In this scenario, our imports would likely also drop, because people and businesses will not have the funds to purchase them. This could get us back to the problem of pipelines below minimum operating level.

How much of this will happen in the next two quarters? I don't know. It is likely that Ben Bernanke and Henry Paulson have some ideas I haven't thought of, and there is a way out of this predicament. I don't have all of the answers. It is likely to be an interesting rest of 2008.

Excellent article. Thanks for sharing your insight. I have a related question that hopefully someone in the oil drilling industry can answer. I saw a recent article in which the EIA stated that even if offshore drilling was allowed, there would be no production from those areas until 2017. That seems like an extremely long time frame. Does it really take that long?

I regularly participate in bloggers calls with the American Petroleum Institute, and this has been discussed. I think the problems is that there are a lot of delays built into the system. As I understand it, the company first bids on the new property. It then has to try to explore the new property, to see if there is any oil. This takes several years--lining up people and equipment, and if things look promising, drilling one or more test wells. Drilling rigs are in very short supply, and there can be very long (1 year +) waits for these. Permits of various types are required and this adds to the process.

If it looks like there is oil and or gas there, someone has to design a plan for extracting this resource. Once the plan is drawn up, the equipment must be obtained, and workers must be located. If oil is in a challenging area, there may need to be new specialized equipment designed and specially built for the purpose. If an oil platform is required, this may need to be built.

Pipeline for transporting the oil and associated gas will typically be needed. If the well is 200 miles out in the ocean, typically both oil and gas pipelines will be needed to extend to the new location. There may be a need to extend land pipelines as well, to connect with the new pipelines into the ocean.

If we were dealing with a standardized process with off the shelf products and without government permits required, the process would take a lot less time.
The length of time I remember hearing is seven to ten years, but I expect that ten is probably pretty typical.

It's hard to imagine you get anything else done with all the effort you put in on TOD. Much appreciated. I suspect you're familiar with Chaos Theory and Complex Adaptive Systems. I'm just a novice on the subject but it's easy to the possibilities you describe fitting into such a format. Given the proximaty and uniqueness of PO even stochastic,or "look back" modeling, might offer not offer a very clear vision of the future.

As much as I appreciate your efforts it is a little overwhelming to see all the weak points of our economy stacked up in one spot.

More approach is more to look at what I see as links, and try to see what happens in some sample cases.

I am concerned that there is a fairly close link between electrical availability and petroleum products availability. For example, if we can't get coal because of a lack of petroleum products, then there is likely to be a drop in electricity available. If electricity is lacking in certain parts of the country, this could be a major problem.

Gail, congrats on a truly remarkable article. You really separated out what is important and made it all to easily understood <--That is NOT easy to do. BRAVO!

Your concern of electricity is one that I share. IF we have a hard time getting oil, delivering oil, etc. then people will switch to electric heat, electric cars (doing this already), and our grid does not have extra capacity to replace the lost value of oil based energy. This is clearly overlooked by the MSM. I think you are dead on that this will be another crisis mixed in with the others that will hit.

You also hit on "never to be sold homes". yeegads!

I think you have done a masterful job of outlining the coming collapse with plenty of real "signals" that will be obvious if you care to look.

I keep thinking that the differences in types of mortgages might mean that the US is more likely to follow an hyperinflationary bail-out program than the UK. Although I still think the UK will inflate the money supply in propping some organisations up, and will face a rapidly weakening currency, making most of the goods we purchase as imports much more expensive. Sadly this now includes the most important things, like food and energy.

As I understand it, negative equity is less financially disruptive in the UK, as mortgagers can't so easily just hand back their house keys and walk away, free of debt (as they can in the US).

Another influencing factor though is that defaulting is much more complicated politically, and technically than monetizing debt to pay obligations. Defaults trigger events in credit derivatives markets, which may cascade out of control. Inflating/bailing is easier in the short term and the impact takes longer to be felt, so it's harder for people to know who to blame. Not sure this makes it inevitable, but seems more likely to me - in debtor nations anyway.

What kind of barriers do you foresee? Do you think they will be forced to stop by foreign creditors withdrawing funding? This might be the case, but I can easily imagine hyperinflation first, what do you think?

I think that the amount of debt defaulting will just become overwhelming. There will be bank defaults that cannot be covered by FDIC and FSLIC assets. There will be the big auto makers and the airlines. At some point, the State of California may default on its debt.

Before it comes to this point, there may very well be problems with creditors withdrawing funding, interest rates rising, and the exercise of balancing the budget becoming totally impossible. There may even be the problems with oil availability that I mentioned, and keeping the pipelines running. If folks at the ends of the pipelines were to get left out, this could be a very bad situation.

I suppose hyperinflation is a possibility, but with all of the defaulting debt, it seems like it would be difficult to maintain for very long.

"I suppose hyperinflation is a possibility, but with all of the defaulting debt, it seems like it would be difficult to maintain for very long."

This situation has me totally perplexed. We are going to do bailouts- that we can foresee, but is that money going to evaporate somehow? I just can't get my head wrapped around this one. It seems like a transfer of increasingly worthless money to the wealthy but they too will be dragged down. Like killing the goose who lays the golden eggs.

Money is created when people / businesses / government obtain loans and spend the proceeds. The amount of these loans looks like it will be dropping precipitously, as the various borrowers default on loans and lenders become increasingly wary of making new loans.

The government may try to bail out lenders, but even with all of this new money, it will be difficult to replace what has recently been available.

DelusionaL,
I have read that using the Case-Schiller numbers so far, about 1.3 trillion dollars of 'hallucinated wealth' (hat tip to JHK) in the form of US residential housing equity have evaporated already. Mish Shedlock, Enrico Orlandini, and other respected analysts believe that the deflationary cascade will overwhelm the capacity of the US gov't credit rating to bail out.

It is difficult to understand how and when the inflation will change over to deflation. For one thing, it happens simultaneously. (Food and energy prices have been rising while suburban real estate equity has been vanishing.)

The thing to keep in mind is that most of our assets only have full value if we're not all trying to sell them at the same time.

Another key point is that as state budgets go into deficits, they will likely choose to defund pension plans and sell off assets at bargain basement prices.

For starters, everyone should check out Chris Martenson's Crash Course. Just google:

"What would be the effect of US States becoming effectively, or practically, bankrupt? or USGOV unable to service international debt? How would this effect the UK?"

If the US goes into catastrophic bankruptcy and continues bailout/intervention + an inability to honor international debt, you can expect more strain on banks worldwide (first Europe then spreading around the world), the increased likelihood of hyperinflation worldwide through all dollar based currencies (read export markets to US) as the treasury prints money to prop up banks and service debt, and a trainwreck of export goods to the US as the dollar falls.

I don't know if things will likely move rapidly to this kind of scenario. Right now, it looks like a slow burn.

I would think so. This is one reason I think that others would be happy to squeeze us out. Who needs an oil buyer who takes 24% of the world's oil for 4% of the world's population, and can't pay for it?

This reminds me of an interview with Chris Skrebowski on global public media back in June, where he says that the US hasn't been in control of demand due to it's stagnant economy for months versus Asia/China.

We appear to be at a unique point in history. The US isn't driving demand for once, therefore it can't set the price with its current stagnation from the international market to lower prices significantly. It would have to take a drastic usage drop to lower prices.

So let's say for every 2% oil usage drop the slack is taken up elsewhere. The price therefore remains the same or rises. As long as there is oil around needed for growth, price won't go down. There would have to be an excessive decline in that 24%. I'm sure it's possible, but wouldn't that mean deep recession/depression levels? What is a depression level usage of oil in the US?

However this plays, excess will just go to growing economies, and those who can afford it, re: not Europe or N.A. Therefore China et al are setting prices, and our analysis would seem to require a shift to a worldwide view as well if we wish to remain kept in the loop.

I am sure you have read about the collapse of the World Trade Organization talks at Doha. I am sure a big piece of this is the new power of the countries with growing oil usage, as discussed in this WSJ article. The US has been able to dictate how trade would operate for many years, but this power is going away.

Before getting too carried away, it's important to note that this is (for all practical purposes) impossible. As a sovereign issuer of currency, the U.S. Gov. can always pay it's debts, since it doesn't have to obtain dollars from any external source (note that this doesn't apply to countries like Argentina that owed large debts denominated in other currencies). The only way the U.S. could cease to honer its obligations is if the U.S. congress decided not to cash U.S. treasury checks - not inconceivable, but highly unlikely.

If our dollars aren't worth very much, our lenders won't be very happy when paid back in inflated money. Also, we have a lot of debt to roll over, and new interest rates won't be very favorable, in this scenario.

You still are not understanding the world from the point of view of an issuer of currency. The U.S. gov. (or any other sovereign issuer of currency) does not have "lenders" in the proper sense. As a matter of operational reality, the U.S. government must first spend money into existence in order for it to be available to be "borrowed". In reality, the only reason for the U.S. to exchange interest bearing instruments for non-interest-bearing currency is to support a non-zero interest rate. Japan ran deficits over 9% of GDP for years during the 90's, ended up with a debt-to-GDP ratio of over 150%, and still had interest rates of roughly 0%. Again, this is not magic - it is the operational reality of a currency issuer in a non-fixed rate regime.

I'm not saying there aren't real problems with the real economy. But to float words like "bankruptcy" that simply don't apply is to fog the real issues.

Ah the dreaded Japan analogies that will not die. Japan has always run strong trade surpluses, unlike the USA. If you think the USA can just print paper indefinitely and foreign suppliers will be content to accept such paper in return for valuable goods (even though the USA does not have comparable dollar value goods to sell in exchange) you are probably surprised that the housing bubble "that never was" blew up. It is fun though-just print up magic paper, provide nothing and get everything.

taking the analogy of paying for energy with 'paper' further, the US has WAY more energy than does Japan, and this disparity largens on a per capita per square mile basis. So in the end, we have endogenous fossil energy sources (though not as much as we 'need') and Japan does not. They have just been more thrifty in how they spend their energy (i.e. no military to speak of)

Japan definitely has energy issues, but my point is that, as you state, Japan is not the USA. The USA has been borrowing from foreigners for many years now as a means of propping up the consumption economy, which is just another artificial bubble. The question is what is the longer term actual value of the US dollar, i.e. the value at which the country no longer needs to run trade deficits. This value appears to be very low-probably the strongest offset would be dramatically higher food prices. This is one part of the ethanol (corn and otherwise) story that is seldom quantified.

I agree that the statement "bankrupt" is extreme, but as BrianT says it is not just as easy as printing money.

States most certainly do have lenders Jimbo and it is called the international bond market.

There are many debt markets for every country. First, is the domestic private debt market--the rate that banks charge each other for overnight loans known as the Fed Funds rate in the United States. This market was not backed by the Treasury until Paulson crossed the Rubicon and the final nationalization of the United States banking system by Bush signing the housing bill. Second, is the domestic governmental debt market known as state and municipal bonds in the United States--these are backed by the state or local government--usually the federal governmental will try to intervene rather than one of these fail.

Third, and most importantly, is the actual international bond market.

Japan was a "good" country that the international finance system supported (for a price) during its housing bubble burst in 1990. In that case, the government propped up banks with government funds because otherwise they would have collapsed as they could not have maintained reserves upon writing down assets and the entire thing would have went down. In effect, the private banking system became public as public money provided the financing for the private banking system. Thus, when the government took all this private debt onto its balance sheet in the 1990's we saw governmental debt rates rise, while the Bank Of Japan rates drop to zero or lower. Look at the growth in JGB and the rates paid from 1990 onward:

The international bond market provided funds to Japan in JGBs (at higher rates) so that the national banking sector could keep giving loans to consumers for almost nothing so the economy did not completely shut down. But they had a lost decade because the expense of paying those rates weighed on the real ecomony, foreign capital did not want to invest in such a slow economy and capital fled the Nikkei, and the Yen strengthened as the rates on JGB increased similar to when Volker raised rates in the early 1980's to high levels and this hurt their exporting business as their cars, electronics, etc. were not as "cheap" as before reducing their trade surplus further slowing the economy.

Now what happens if you are not a "good" country and the international bond market abandons you? Zimbabwe had public debt that their trading partners required be paid or they would cease trade. Zimbabwe was viewed as a "bad" country, I have no opinion on good or bad here I'm simply trying to visualize structure, and the international bond market stopped providing financing. Therefore, to continue to receive goods from trading partners they needed to pay their debts and the only way to do so was to print currency and the hyperinflationary spiral began.

The same thing happened in Argentina, and since capital fled, there was no money in the banks and access to the banks had to be restricted.

As to America, I am of the opinion that it is considered a good country even if not well liked right now in the world and will get financing. In addition, like it or not, America is the police of the world and I don't think any country really wants to see America collapse into nothing. Also, the exit tax is designed to prevent the wealthy from renoucing citizenship and fleeing with their capital without paying large amounts of taxes on their wealth hindering capital flight. And the U.S. has the muscle to back such a law. I could be wrong.

The increased activity between the European Central Bank and the Federal Reserve, such as accepting covered bonds as collateral and currency swaps, leads me to believe they have joined ranks and therefore the value of the dollar will be a function of the differential between the Federal Funds Rate, the ECB bank rate, and the strength of the Yuan. The ECB can issue currency and swap for dollars and put them on the shelf reducing supply to support the value along with the Chinese. I think they want the dollar weak--but just not too weak--cheap to buy our assets, increases our exports, and increases the cost of oil curbing consumption.

As to future speculation, the following is extrodinarily rampant, totally imaginary and perhaps connecting dots where there is absolutely no basis for doing so, but its my current flight of fancy:

Everyone knows that London and Zurich are absolute centers of finance and Sterling and the Swiss Franc did not join under the Euro. Everyone knows the housing situation in Britian is worse than here and the bad thing for many British banks is that they hold the bloated mortgages on their books--they can't dump them to private equity like covered bonds or CDOs. This could require more Northern Rocks and eventually the Bank of England could be sunk as its not clear how the international bond market would treat Britian.

The Fed will have a derivative clearing house created by December 31 as security in the event a major market maker fails:

Again, all crazy speculation but I quite enjoy trying to figure out the events of the day and the possible interconnections between them. This discussion makes me think of one of my favorite movie lines:

Godfather 3:

Vincent Mancini: Don Lucchesi, you are a man of finance and politics. These things I don't understand.
Don Lucchesi: You understand guns?
Vincent Mancini: Yes.
Don Lucchesi: Finance is a gun. Politics is knowing when to pull the trigger.

Ben Bernanke, you have studied the Great Depression your entire career. Please take the stage.

Remember this is massive speculation on the order of Bob Shaw. The reality of these words actually occuring are about as much as a Huber-Lynch oil field where I can raise Unicorns. I am simply taking a flight of fancy.

The Bank of England has always been very powerful, in fact, in my opinion it is the most powerful central bank even more than the Federal Reserve because of the LIBOR:

In the past, the Federal Funds Rate and the LIBOR were almost always identical and one could say connected to other. The connection is that they are both dollar rates--the LIBOR determines the amount of Eurodollars on deposit for foreign central banks in the major banking houses in London and is the primary currency used to settle international transactions. Fed Funds are for domestic dollars.

The deficit next year is expected to explode. The LIBOR rises as Fed Funds stay the same since massive amount of dollars are moving out of country. A rising LIBOR (London Interbank Rate) damages London Banks as the cost of their financing increase (at the very same time they want to lower rates since their housing market is collapsing).

The Bank of England has taken direct measures to try and influence LIBOR down by pumping Sterling into the market but it hasn't been too successful:

In addition, the Bank of England now wants to cut rates to save its housing market.

On the other side, to dampen inflation from Eurodollars, the ECB raises rates and performs currency swaps increasing its float to prevent complete collapse of the dollar, along with the Yuan buying up dollars. In addition, the ECB raises rates--England is at 5%, ECB is at 4%, and Fed at 2%. If ECB is equal or higher than England then capital will flee from the Bank of England into the ECB. And the housing bust will be getting worse as the LIBOR rises.

At that point, England will likely have more Northern Rocks. And like where the US is now, will need the international bond market to fund their banks or they collapse subjecting them to the world marketplace for both finance and oil--a position they have never been in before. Will someone save them? And if so, on what terms?

The result would be the death of the LIBOR, perhaps the pound Sterling, and a major shift of power in finance away from the Bank of England.

These are scary times. I am certainly frightened. Power is shifting in a major way. I'm not sure what actions might be taken. People get violent. I don't know how long or when but things are certainly changing. The nationalization of the US banking industry is absolutely historical.

What does this have to do with oil, you ask?

Everything. Once the North Sea collapsed London was vulnerable--they would soon become an importer. Also, the international oil companies such as BP, Shell, Exxon were losing production meaning a loss in leverage concerning OPEC as Non-OPEC started to peak except Russia who is not exactly buddy-buddy with the West. The Middle East was the prize. France & Germany (members of the ECB) had contracts with Saddam Hussien for oil lined up prior to the invasion and if you remember were the countries attempting to block London and the US in the UN prior to the invasion.

London & the US went alone over the objection of the UN. Perhaps they could break OPEC open up new markets and keep financial power. But the war was not successful (maybe the amount of oil found wasn't so much) but the Pentagon needed a secure supply that was obtained in Iraq and I'm sure nobody really wanted to see Saddam stay in power. Cheney pushed to attack Iran and expand the theatre but was stopped by the Pentagon and the intelligence community. Cheney talked to Saudi king maybe pushing to attack Iran and Saudi rejected.

Not that Iran is a good state by any means, but the UN prefers crippling sanctions to war.

In my opinion, we are seeing gigantic shifts in power right now. My sincere hope is that war and violence is not used by those attempting to cling to power.

The only way the U.S. could cease to honer its obligations is if the U.S. congress decided not to cash U.S. treasury checks - not inconceivable, but highly unlikely.

You are mistaken. Should China and OPEC cease buying US debt, or conversely start unloading US debt, the dollar would collapse. Nouriel Roubini has been speculating that the end of Bretton Woods II may be near. In that case, the US would have no option but default. It is anything but unlikely. The world's central banks are getting tired of propping up the US by recycling its increasingly worthless dollars that are now causing hyperinflation in their nations.

a good video you might like is Robert Newman's A brief history of oil...

He muses about Euros becoming the new reserve currency. All OPEC has to do is stop using US Dollars and use Euros instead. All those dollars would go back to the US and the US would have to exchange Dollars to Euros, flushing the market and devaluing the Dollar.. Thus the Dollar currency would crash, even more so. That all oil transactions occur in USD is probably the only thing keeping it up?

Agree with energyblog. Another thing propping up the dollar, in spite of the shambled US financial situation, is the huge amount of dollars and US investments held by Japan and Middle Eastern countries. None of these countries want to see a catastrophic decline in the dollar and probably do not dare demand other currency to replace the same because of the triggering effect this would have on further decline of the dollar. It is a catch 22 situation for those countries.

the US has major problems but the Eurozone has worse. As credit crisis continues (and we are not even half way IMO, though it may SEEM that we are - definitionally 5 standard deviation events go 2 standard deviations further than anyone expects before the fact), there will be several countries in Euro that can't pay bills without cash infusions and central banks will be forced to act - however they will have to act in unison according to charter, and in times of stress old enmities will surface - I think short term dollar is strong, intermediate term dollar is weak (vs euro) and long term dollar is strong (vs euro). Really long term there are likely no currencies except local ones. But lots of wood to chop (literally) before we get to that point. And there are outs (some)

It's not getting carried away at all. Technically being able to pay your debts is fine. The bankrupt part comes when no one wants to buy your debt at which point you are bankrupt.

E.g. You are unable to issue enough paper to willing buyers to buy say
manufactured goods and pay for oil imports.

E.g. You go overseas and people do not want to accept US dollars due to hyper inflation.

So yes a Mugabe type can always pay interest on his sovereign issued paper. (Technically NEVER EVER bankrupt) There is a point where effectively you are bankrupt, in the sense of people wanting to accept your currency falls dramatically.

The pipeline problem: are you saying that the oil infrastructure has developed in such a way that it requires a lot of oil to function properly? So that if the US doesn't have a lot of oil, the oil infrastructure will break in various ways?

Pipelines are sized for the amount of oil that they are to carry through them. It is my understanding that they don't work for a whole lot less. Or perhaps, the oil won't get to the end of the line, with a whole lot less. I want to more fully understand how precisely this works, and write a longer post specifically on this subject.

My fear is that if we have too little oil for the pipelines, the allocation of what oil that is available will be based on whatever is expedient -- say, piping the oil only as far as it will go. That could leave fairly large areas without petroleum products. This method could be a problem. For example, areas that need petroleum for coal mining might not be able to get the petroleum products; some of the farming areas might be left without petroleum products to run their equipment. I need to investigate this further. Perhaps some readers have insights on the real workings of the system.

Pipelines are sized for the amount of oil that they are to carry through them. It is my understanding that they don't work for a whole lot less.

I dunno about that.

They can just slow down the pump speed or just throttle the flow(choke down a valve) reducing the velocity of the flow.

The design velocity is 10 feet per second with a maximum of 15 fps and a minimum of 3 feet per second, so running at 3 fps would reduce capacity by 70% of design and we're not going to reduce crude oil THAT much anytime soon.

I know in some pipelines there is water present so maybe water could be added to make minimum volumetric flow, though it makes little economic sense to move oil and water in a oil pipeline. Is this really a problem?

I don't know about oil pipelines. But here in Germany we have this problem in depopulated areas with water and wastewater pipelines. When population decreases and water consumption decreases the water becomes increasingly stagnant, so that bacteria may grow and the wastewater lines become "smelly". In these cases the operator has to flush the pipelines regularly, causing additional costs. Some even encouraged people not to save water (which is spoiled by the flushing anyway, but to be paid by the operator).

I think it's simply logical to point out that the problem Gail refers to would occur, and not be avioded as majorian hopes, when a single large-diameter pipeline is used as common now, to ship multiple products in fairly small individual quantities for long diatances. I believe common practice now is if eg. 36" pipeline (7 cu ft. / ft of length) going 1000 miles exists, and the pipeline company needs to ship say 5 products in it (gasoline, diesel, crude, lubricants, jet fuel etc.) then they will just sequentially inject each of the products, separated by a 36" diameter sealing plug between them, and the product between it's plugs travels the pipe to the destination(s) where it is selectively extracted to various storages, and the seal plugs are recovered once all of a division is extracted.

So say the pipeline company is accustomed to shipping "250 miles of diesel (6.2 x 7 x 5280 x 250 = 57.28 million gallons)", then 400 miles of gasoline, 150 miles of a third product, and 200 miles of a fourth product each week, in that order, and diesel storage facilities at the destinations are set up to supply local demand for the five days out of seven when other products are coming out of the pipe, but not much more. If shipping volumes drop dramatically unexpectedly, then there may be times when the pipeline operator has no product available to "push into" their end of the pipe, meaning that the delivery point which was expecting to get it's 2 days of delivery of diesel on Monday and Tuesday might continue to see only slow flows of other products for an additional week. Their local storage won;t be large enough to bridge the gap, so the local market goes without diesel for the week.

We could suggest "well, just push in some other product to make the diesel come out the other end". But first, the pipeline may not be designed to handle the corrosion of unusual products, and second, that'll be a huge volume of contaminated water (if that's what's suggested) coming out the other end at some point which must be properly dealt with. And no doubt there would be a certain rate of leakage across the moving seal plugs. Contaminating the first mile of diesel following a load of gasoline with a few percent of gasoline is not a huge issue, the engines wouldn't even notice. A few percent of brakish water though, may be a more serious issue.

Obviously, the issues "should" be manageable by reducing the size of individual injection volumes so that delivery-point timings are unaffected by slower travel rates, but means much more precise sales volume predictions at each of the many delivery points, with a greater liklihood of error.

Disclaimer: This is all based on just my speculation, and I have no actual inside knowledge of the problems involved. I may be way off.

I think it already happened. There were fuel shortages in the Dakotas last year, and they complained it was because they were at the end of the pipeline, and were left with the crumbs. It was especially a problem during harvest, when the farmers needed diesel.

I know that there have also been problems in Colorado and in Canada, blamed on being at the end of pipelines. Also, when supplies of gasoline were low last year (?), it seems like Matt Simmons was concerned about the possibility of East Coast pipeline shortages.

So the situation is similar to the Colorado river, where water districts divert their water allotment via pipelines of their own and eventually nothing reaches the other end? The Colorado river used to reach the sea.

I talked to a fellow who worked on getting the Colonial Pipeline going again. He said that power outages along the coast after Katrina hit caused the pipeline to stop moving oil. He was with one group of people who moved a diesel generator up to the pipeline, and used it to generate electricity to get the pipeline going again. Oil from the pipeline was used to power the generator. It sounded like state troopers watched over the operation. There may have been several places where this type of operation was needed, to get the oil moving again.

Your statement that some mining operations could be put at risk because of a shortage of energy inputs
is worrisome. This of course has already occurred in South Africa. My state of Wyoming supplies 38% of the steam coal used to generate electricity in the US but our biggest regional power plant, the Jim Bridger plant in SW Wyoming mines it's own coal with a huge electrical umbilical power cable powering the massive coal shovel. The coal mined in other areas of the state such as the Powder River basin depend on diesel to mine and the railroads to transport coal out of state. Our state does have refineries which produce the distillate fuels making the state theoretically less vulnerable to fuel shortages. The pipeline issue you raised is disturbing if true. But the complexity of all these interconnected networks poses great risks, not all of whom are readily apparent to an incompetent government, a media lacking scrutiny and an uneducated and inattentive citizenry. Thank you Gail for your continued superb and independent work.

I visited the BP installation in Wamsutter in May and could see that natural gas production there depended on having oil. If nothing else, workers need food, and this generally requires shipping food to Wyoming, often by truck. I don't understand the electric situation as well, but there are so many interconnections, it seems like there is a lot of risk for failure. If anyone tries to do rationing, I am sure they will miss some of the critical needs to keep everything working.

Gail;
I think this dependency of one fuel type on another is worrying, the very heart of complexity, and to put it in the context of one of my little soapboxes, I have been asking those who join into Nuke/Anti Nuke conversations to say if they have heard of any studies that have been done on the complex (or maybe not so complex?) string of continuous dependencies that a Nuclear reactor has in order to maintain steady and safe operation. Whether it's the ability of the workforce to get to the site, the consistency of the roadways and trucking companies that provide parts and regular supplies, or the suppliers of the specialized and energy-intensive parts themselves, that these plants require.

Probably part of a different (and more difficult) conversation, but I felt it applied to the general issue of how much and what kind of energy any given energy source requires to keep the power flowing.

Even cash is not safe. Money created by bankers out of thin
air. The thing with all this financial mumbo/jumbo is "the amount
of money is limitless". All this run into the brick wall of finite
resource. In the end, it's the resource that matter. We'll all be fighting for it -- whether it's oil, land for crop, etc... Of course, a lot of us are betting that "things won't get that bad in our lifetime" -- our grand-children will have to put up with it.

I think the point that it is the resources that matter is a point that a lot of people don't understand.

When looking at the future, most people seem to follow the approach of taking today, and projecting forward, using compound interest. This is the financial planner approach.

I personally have not worked on Social Security funding, but I discovered when reading about it that one approach was to look at what resources were likely to be available, and divide those resources between workers and retirees. With declining resources, I think that this is the only way one can look at things. I use a little of this approach in my post/talk The Expected Economic Impact of an Energy Downturn.

Exactly, it's all about the resources, and how we are going to pay for them.

When looking at things from a global perspective, it's just striking how much money is tied up in otherwise worthless real estate.

Why worthless?

Well, consider we are bidding for oil in the international arena.
India offers cheap yet well educated labour in return.
China offers cheap and reasonable quality consumer goods, 'must have' gadgets.
Other countries might offer minerals, or agriproducts in return for oil.

What does the US have to offer? Residential buildings? Who would sell oil in return for houses which are loosing value?

Ok, since Bretton Woods, it was the US$, everyone trading on a global scale had to have. So for the US it was really that easy: just print enough Dollar notes. And as long as more and more countries needed to pay for their imported commodities and later oil in US currency, retaining its value against other currencies was guaranteed.

But it's coming down.

There is a marked trend since the start of the new millennium, in the number of countries dropping the traditional reserve currency denomination in favour of the Euro. The outlook for the Dollar simply wasn't/isn't seen as promising as the Euro's in an expanding (eastward) market.

So, in order to successfully bid for the world's oil, the US will have to find something new to throw into the deal.

How about human rejuvenation, techniques for reversing the ageing process?

There are two things that have kept the dollar and our economy from complete implosion...the flow of petrodollars in US currency and the US military to maintain that flow. This is why the Fed Gov says that if the US fails, so does the world.

Yep, the ol' petrodollar cycle...
In pre-euro times, this cycle closed itself almost exclusivlely in the US.
If we still were under these old conditions, the US just would rake it in at currently sky high oil prices (via their OPEC friends).
But the re-development of infrastructure in oil producing middle eastern countries has drawn other players to the table. Members from euro-land so to speak have won numerous lucrative contracts. And these new kids on the block are not getting paid in riyal. No, they take the greenback instead which they can use to buy other commodities and oil which they smartly convert into goods and services their desert dweller friends desire....
And because the petrodollar cycle has gotten a new brother called petroeuro cycle things are being shared more evenly.
It has been said so often, too much money on the market chasing too few goods, but now it's too little money chasing too few goods - stagflation....
If I understand this right.
And I strongly believe the US has some smartness up its head to devise a plan of adaptation rather than throwing the whole planet away.

As always I appreciate your thoroughness. I just thought that I would mention that is the US is unable to procure sufficient credit to continue to purchase imports (or to "ration" which they do procure), there are a LOT of imports that the US could do WITHOUT (e.g. toys from China, etc., etc.). Also there is LOT of energy consumption that is not so critical (driving to movies, driving to the corner store, driving to work when telecommuting would work as well, etc., etc.).

I also believe that China especially, but also many other countries would be very willing to keep financing the US for political reasons. For example, China will want to be able to exert pressure on Taiwan and the US Navy could be a significant "thorn" in the side of any invasion force sent by China to Taiwan. Also, the Chinese balance of payments is not SO large with other countries that they could readily afford to see the US cut back on non-essential imports.

There are plenty of good reasons for many countries to keep financing the US debt monster apart from strict short-term profit reasons.

Finally, I thought I would mention a key question: What would happen to the massive US export surplus in Agricultural products if the US was not able to continue to purchase oil?? Wouldn't that mean that many countries would go hungry, en masse?? At some level, the US farm sector may "save" the US because so many people depend on the US to sell them food. Also, if the US were to reduce its meat consumption, there would be more export surplus in grain to help with the balance of payments problem.

In Summary, I think that there are SOME factors that would help mitigate the WORST of what you suggesting (although I strongly suspect that you are correct in your overall thinking).

I would guess that there are actually more than 2.1 million vacant homes. Some people are waiting to put them up for sale until "the market gets better".

My mother owns a townhouse but lives in an assisted living center. The townhouse is only used for occasional visiting out-of-town relatives. The house is not really needed, but it is paid for, and my mother doesn't need the money. There isn't much of a market for it, so it hasn't been put up for sale.

So Gail, are you actively pursuading your mother to sell the townhouse? From your post, it seems like you'd be most concerned that your mother might have an empty house in a crashing credit market and bank-failure era.

I stay out of this one. She doesn't need the money and other investments aren't particularly safe. The townhouse is in a reasonable location, near farm land. It might be in a reasonable location for my family or one of my siblings to live post-peak.

Preliminary estimates are that the IndyMac bankruptcy will cost $4 to $8 billion. The FDIC Has $53 billion dollars in assets (to insure $4 trillion plus of bank deposits). The 15% number comes from dividing $8 billion by $53 billion.

This is a link to a WSJ article on the subject. I changed the link above to this one as well.

Thanks for the article Gail... follows much of my thinking, and adds things I haven't thought about. Do you/does anyone, know anything about the UKs FSCS (equivalent of FDIC I think)? I'm not sure what assets it has, maybe none!, maybe any use is just added to the government deficit?

I looked at the FSCS web site. It looks like they started the year with £103.4 million, and are planning to collect levies of £28.3 million, to bring their total fund balance to £131.7 million (from here). This is not enough to cover any reasonable size default.

There is a new plan, effective April 1, 2008, that permits levies of up to about £4 billion each year from insured institutions, if there is a need for this much. The US bankruptcy of IndyMac is estimated to cost from $4 to $8 billion dollars, so this is the equivalent of covering a maximum of one IndyMax loss per year. The plan seems to apply to pensions, general insurance, life insurance, bank deposits, brokers, and a few other categories. Any loss from one of these would go against the £4 billion total available annually.

It looks to me as if the fund won't go very far if it needs to cover multiple large claims. UK seems to be in as bad shape as the US in this regard (or worse).

Thanks. I didn't manage to find that page when I looked previously, or didn't quite understand it. I watched a couple of recent Treasury Committee hearings on banking reform, partly relating to the FSCS. It seems that there are different provisions for deposit protection depending upon whether the bank is a UK bank, a European Economic Area bank(EEA), or a non-EEA bank. The whole thing seems quite confusing, and quite obfuscated, but you're right it looks like there's not enough to meet the bankruptcies I'd expect.

The media has portrayed deposit protection (of up to £32,000) as a certainty though, so I guess the government would have to step in if/when the FSCS fund is exhausted.

Incidentally, they are apparently attempting to introduce new banking legislation in the autumn, to clarify responsibility for financial stability... but will it help, or even come in time?

The FSCS can cover one big claim or a handful of small claims. The government can step in and handle a few more -- say five times what the FSCS covered. The problem is that with huge numbers of people unable to pay their mortgages, the number of failures can be bigger than even the government can handle. What does one do then?

If you're right that the government won't be able to inflate to provide the required deposit protection, it seems likely that at some point there will be total chaos, and imposed limits on daily cash withdrawals etc.

I still don't fully understand what prevents them from nationalising the banking system, in the style of Northern Rock, and now what seems to be happening with Fannie May and Freddie Mac though - what prevents them from increasing the deficit? I know that doing so will destroy the currency and create massive inflation, but find it hard to see a better choice for them.

It has to be said that in the UK there is an very noticable increasing police presence. This will be needed if they start limiting withdrawals!

If a country inflates the currency, it will still work for transactions within the country, but currency loses value for buying overseas imports. The UK would do very poorly without overseas imports.

The amount of US external debt is $5 trillion. Adding the liabilities of Fannie Mae and Freddie Mac would add $5.3 trillion, so would more than double the US external liabilities. The amounts are so huge that no one dares suggest actually putting the amounts on the US balance sheet.

Ouch, It's nice to see someone who presents their past predictions for review versus the predominant pattern of forcasters to try to hide any poor predictions under the nearest carpet.
One of todays scary factoids that I heard on Bloomberg this am discussing the huge GM losses just posted is that large SUV's going to auto auctions are not getting any bids whatsoever.
Sure the decline in house prices is painful but many owners will not move and keep making the payments, but imagine what happens when folks realize the SUV they paid $40,000 for last year is now worth not $30,000( expected; drive-it- off- the- lot onetime depreciation) but 10,000 or 15,000? This is a more direct impact to folks perception of wealth or predilection to spend than possibly the housing crisis.... GM's estimate is each SUV coming off a closed end lease is $11,000 under their forcast residual value. How many smaller dealers can afford to accept $10,000 losses on trade-ins already sitting in their lots for 4-8 weeks?
Systemic- no but serious condition in a bellweather consumer segment

I agree SUVs will be a big problem. If people have an SUV plus a smaller car, I can imagine some of them just stopping making payments on the SUV. The lender can have it back, for whatever it is worth.

I expect the consumer segment will be showing more and more anguish as the year goes on. I think the ones that are hurt hardest right now are those living on close to minimum wages.

It's not just the SUV --- it's our lifestyle. When I saw my sister's closet with hundred of shoes, I can see why we are in the situation we're in. When we have super-sized meals and wonder why we're fat and where are our resource goes -- it showed situation we're in. Capitalism pushes people toward consumerism -- it seemed that you can't have a good economy unless people spend money on junks. That's why the President gave everyone $300 to buy more stuffs to stimulate the economy. Time to stop and think and get ourselves out of this slavery mode. I am all for making money but "at what cost to us and our future generations". Somehow, not too many are concerned with the "future cost".

There is really a three way split: spent, saved, and paying down debt. There seem to be a number of small surveys, with differing results. The surveys show 25% to 45% of stimulus handouts used for debt pay-down. These are a few links:

Bernstein cited polling conducted June 3-10 that found consumers who had received their rebate checks had spent 42.9 percent of the money, but that nearly half of the money spent had gone to gasoline (9.7 percent) or necessities such as groceries (10.4 percent). The total of those two categories exceeded all other spending categories combined, with the next-largest category – clothing and apparel – amounting to only 3.3 percent. Consumers said 25.2 percent of the money went to pay off debt and 17.1 percent went into savings. The polling was conducted by BIGresearch, an Ohio-based firm that conducts regular consumer surveys for NRF.

Despite government efforts to increase consumer spending through the economic stimulus program, the June survey of 2,483 online shoppers revealed that 89 percent of respondents are still cutting back. Similar to the results of the April tax refund survey, more than one-third of consumers who indicated they spent their economic stimulus checks used them to pay off debt. Thirty-one percent of online consumers spent their checks on retail shopping. Of those who spent their stimulus checks, 27 percent bought one large item and 25 percent spent the money immediately on multiple items.

thanks for this update Gail. glad tod has u onboard as finances is the main peak oil [US] casualty these days & having a bit of an ira still in the fray i am all eyes & ears to steer as best as i can for me & my family.

i learned of peak oil 3 yrs. ago & didn't know a bid from an ask yet took control of 3 relatively small iras' to try & keep what little financial security we could from the peak oil tsunami & maybe turn a buck as i don't expect my SS to be of much help.

i am somewhat amazed that u tie abrupt defaults with the US moving below minimum operating levels in the oil "pipeline". i have a hard time seeing the connection as that 'immediate' that the cause & effect would be clear & apparent. couldn't we use the SPR too? or, are u thinking about a 6 mo. time lag or so - financial to spot shortages.

one of my biggest concerns is deflation vs. inflation. it makes a lot/fair amount on how i place our bets!

my impression is the inflation route is already chosen & cannot readily be changed. but could we get obama & volker maybe? & a turn around after the elections.

& a no. believe the fed will be overwhelmed by the rate of defaults & deflation will over take us. certainly the gov can deposit $ in our accounts overnite & we are trained to spend [as long as our bank is still functioning].

i gather a semi-controlled default rate- as we are having ,will allow the inflation scenario to work. u'r thoughts?

I think we will aim for inflation, but will end up with a lot of failures that simply cannot be rescued. This may sound strange, but I am concerned that electrical outages will become such a problem that we will simply lose track of a lot of electronic assets. If this happens, is the result deflation?

In the long run, all we can divide us is the actual resources on the earth's surface. It seems like a lot of promises have been created that can never be honored.

gail
u'r concern about loss of electricity is a primary one of mine.most cities would be in serious trouble.

i worked long ago at a very large power plant. one of my first fears when i learned of peak oil was loss of electricity. i think intuitively i associated all the diesel/oil i saw associated with the producing & transmission. we then had oil burners to fireup the boilers.at least these have been replaced with nat. gas i have read.

even ash ponds would be a major issue i would imagine [catabolic collapse- leaving waste wherever]. at least the coal came in 100 car [unit] trains.

hopefully loss of power will be gradual/intermittent; though i am a little ways out & we could lose power quicker- permanently [reluctantly bought a generator this past week- it will run off my heating oil].

we have also had our lines replaced in our area due to age/failing[60+ yrs. old] & what a job- hilly terrain.

if we lose electronic money then this would be global currency collapse- correct? forgive if i have trouble connection financial dots- quite green at finances.

I think it would depend on how severe electricity outages are. If it is a few local electricity outages, it seems like they could be worked around. If it gets to be more widespread, then there will be a real problem.

I am not sure how all of this will work globally. The US is quite tied to Canada, so these would likely be a spill over there, and UK is very much into the same financial products that we are. As one gets farther and farther away from the US, it seems like there is a possibility that a fairly large chunk of the rest of the world could readjust fairly quickly, and go one without the US.

Nate talks about the US dollar not going to $0 before WW3. I am not convinced of this. Wars are very expensive. We haven't been able to do much, even attacking countries that seem to be fairly defenseless. I may be looking at this from a female perspective, though.

Gail
First reaction is what is happening now -Paulson and Bernanke pulling rabbits out of hats.
Second reaction is concerted global central bank interaction, attempting to walk line of moderate growth without runaway inflation, paying lip service to US hegemony but only on the surface
Third reaction is breakdown in international currency system - if this happens and say, dollar/Euro declines to 2.5-3:1, the US economy would be in shambles and we wouldn't be able to afford oil. At this point the dollar is worth half of what it is now. The people in power wouldn't just ask for other countries help in resources. They have become (at least for the moment) habituated to power - they will choose teams and rationalize some international event as necessary to defend and WW3 starts as a resource grab (which most wars have).

There is absolutely no way the dollar become worthless a la weimar germany without it precipitating war first. And the international governments know this so they will (at least in OECD) do everything possible to avoid a dollar collapse. (a 20 year decline in US hegemony is probably something many countries wish for, but a fast collapse would be a nightmare for everyone - actually in the US it would be less of a nightmare, relatively speaking, because we have the most firepower (not that I would want to see it....)

This has been the longest, richest, period in history without a major military conflict (not counting Iraq). We have a become, through no conscious fault of our own other than following the wrong stream downhill, a culture unaware that peace and prosperity are usually historically truncated, and that our entitlements are really quite special, and not entitlements at all...

I agree that we will likely see much more war - and maybe WW3 - before such a devaluation. Another useful purpose it serves is to get society banding together against a perceived enemy, when without it they would likely turn against their ruling classes, blaming them for the state of the country.

Unfortunately, it also seems quite plausible that (in part) because of the state of the armed forces, and economies of the UK and US at least, their will be nuclear threats and possibly attacks. Invasions must be more expensive than nuclear attacks I fear - for the attacking side I mean.

I also think wars have a financial purpose, and can foresee societies being mobilised into war economies. When populations no longer serve their function as consumers, their labour can be exploited by fascist regimes relying on patriotism (as a way to help enforce stable austerity).

In considering resource grabs, maybe if the ruling elites can successfully grab (even more) resources from the lower classes in some form of totalitarianism, WW3 may not (yet) be deemed necessary. If they cannot impose this level of austerity on their populations it becomes more likely, as they will have to grab it from other nations. What do you think?

I hope we can manage to avoid the scenarios we're discussing, but things seem to be moving very quickly now.

gail
'In the long run, all we can divide us is the actual resources on the earth's surface. It seems like a lot of promises have been created that can never be honored.'

yes. this is my primary strategy : buy anything i think we will need in the next decade that will store. took out 1/4 of the ira already & took the penalty & tax hit. psychologically one of the harder things to do.

this works deflation or inflation; or collapse.

the connection u see of financial failures & electricity loss is purchasing ability for oil, right?

the sensible things to do first with shortages of oil is AG/food services & electricity. i hope we get our priorities straight.

i'm 'getting' the Orlov [& u'r] sense that financial failure can happen quickly. i have felt that but am so green there that i presumed it might be panic on my part.

The difficulties I see with the buy what you need for the next ten years strategy are:

1. It really isn't too feasible. Maybe, with a lot of work, you can get enough food for a year, and a few other supplies, but people quickly run out of storage space and money.

2. If you have to move quickly, and fossil fuels are not available, transporting all this stuff is not feasible.

3. Other people will see what you have and want to take it.

4. Eventually you will run out, and be where you would be without the stored supplies (except for say, pots and pans and knives, which last a long time). You will have to get to a sustainable position very quickly, regardless.

thanks for your thoughtful reply . it helps me think thru the issues ;& how to communicate about them.

i overstated.

but wire , lumber, hardware stuff , socks, etc. yeah. & we don't have much extra $.i do say to my wife something like the 10 year bit; she rolled her eyes just today re this.

the attitude of ready to leave [recognize the signs- as opposed to the comfort of place/things]it all is important too- a question raised by our adult daughter. transporting things -when few can -after significant societal decay will be incredibly dangerous even if u have the fuel.

i agree also re sustainability.It is the key here & that is a whole nother life than the one we know.to get there quickly makes me think of naomi klein's shock doctrine but in a positive way- so to speak -self imposed to get the radicalness of sustainability.

as for as nearby others- we need to run out of many things about when they do.

I don't think we know yet about whether Duncan is right. A US crash could push the world well on the way toward a downward spiral. Even his timing may prove to be right, but we don't know yet. For those who haven't seen it, this is a graphic from a recent discussion of his theory.

It sounds like I am talking about is consumers being limited in the amount of, say, bonds they can buy, when I mean that the amount of credit they can obtain is likely to decline.

I won't change it now, since that is the wording I used six months ago.

When you stop and think about it, "credit" has a positive connotation and "debt" has a negative connotation, which is probably why I used the latter word. I agree that credit would be the more standard wording.

I have thoroughly enjoyed and highly appreciate your insight on this subject.

I feel in bad form to nitpick, but noting you have placed your work here first for preview and discussion for later wider distribution, I offer the following proofreads:

Background

My January forecast provides a more detailed explanation of systematic risk bias and systemic risk.

How much of this will happen in the next two quarters? I don't know. It is likely that Ben Bernanke and Henry Paulson have some ideas I haven't though(t) of, and there is a way out of this predicament. I don't have all of the answers. It is likely to be an interesting rest of 2008.

(I am hardly qualified to throw stones, knowing all the typos I make. Hopefully, the compiler catches most of 'em ;) )

Gail: Loved this detailed article. Since I myself was
reluctant to attend the Wharton school of economics at
University of Pennsylvania, I found it necessary to
look up the definition of the term recession. Seems
a nut shell definition is any two quarters showing a
10% or greater decline in a given indice or market.
Since we have exceeded that,I would agree we are in
a recession.As regards the mention of inflation,the
government has taken out of the mix all things that
have gone up over 100% and then said inflation was tame.
Also the constant revision of formerly released numbers tends to muddy the waters quite a bit as all
recent revisions have been of a downward type from
previously released numbers.
Keep this info flowing Gail!

Lenders, and those who write insurance against loan defaults, assume that the future will be much like the past. If there is problem with loan defaults, the assumption is made that higher defaults are likely to be temporary.

This is the problem I see bearing down on us like a freight train. Exhibit A: the way states are reacting to budget problems.

It's all short term solutions. They're gutting their rainy day funds. They're borrowing against future income (the next three years' worth of lottery revenue?!). Temporarily forcing state workers to work for minimum wage (they'll have to repay them eventually). It's nuts. Next year, if things aren't better, they'll be in twice as much trouble, with all that borrowed money to repay.

According to the article, New York state saw a 97 percent drop in banking taxes from a year ago. But they see it as temporary problem. The governor is calling for federal help. He wants to spend his way out of it. Hey, it's always worked before.

Even people who sort of understand peak oil have a hard time understanding that this affects the rest of the their lives also. All of the old "rules" regarding recessions being temporary, and investing for the long term go by the wayside. People can't believe that the current way of life is likely to change.

I don't see this just as a one-time, transitory phenomenon, either. To take the stock market as one example, even as it declines all the way down to zero there likely will be bull rally after bull rally. People will grasp at any straw of hope in a turnaround and temporarilly bid equity prices back up - for a little while. Then the slide will inexorably recommence.

Unfortunately, that phenomenon will result in the stock market being littered with a large number of "bear traps" over the next few decades. Just operating on the assumption that the long term trend is down won't be enough - many non-astute investors will lose their shirts playing that game. This same principle holds for just about every other type of investment as well.

In his defense, Paterson has called a special session and is asking for budget cuts. He's actually being somewhat more proactive than say, Ahnold in CA. But the real problem is that no one's going to stand up and say "Game over." Even Gail is just saying she's more pessimistic, not that we're screwed big time.

Worse, if FIRE doesn't make a big comeback most of the U.S. has no real alternative. So pretending it's coming back has no real downside. You're going to end up in the same place no matter what you do.

On the other hand, unlike the FedGov, most state and local gov'ts are required by laws to balance their budgets, and even if not legally required to do so as a practical matter they don't have the freedom to get too far out of balance. So, one way or another, most state and local gov'ts actually WILL have to do something, rather than just play political games and try to kick the can down past the next election cycle.

A few state and local governments undoubtedly will fail to have the political leadership necessary to prevent disaster; these may end up in recievership and effectively run as judicially-appointed dictatorships for lack of a better alternative. Maybe some state or local officials will even be thrown into jail on contempt of court charges. Seeing this happen to a few places should help focus some minds quite a bit.

One thing that we can all count on: state and local governments will not be able to afford to do as much in the future as they have been doing in the past, and are going to be in budget cutback mode for a long time to come.

It seems to me that we are going to have a huge loss of stored wealth, one way or another.

One thought that has crossed my mind is the possibility that we will have such massive electrical outages that we simply lose track of a lot of electronic assets (and liabilities). This doesn't fit either into the inflation or deflation category--it is more that real resources become primary and electronic resources lose their value.

forgive my musing here I just want to follow a train of thought and see where it goes...

Yes I believe subtraction is going to be the hardest concept to accept. Based on your comment then, should real resources be the new currency as electronic resources lose track of asset/liabilities due to blackouts or other reasons, then we're looking at currency based on local conditions. Really then, a local currency. The current scale of international trade as a basis for local economic wealth could then not continue. Some new level would have to find a balance after a period of major decline based on new terms.

Not sure of the mechanics of a local currency, but wouldn't it resolve issues of employment and currency secruity by maintaining local relationships of needed good and services versus a USD currency demise? I also wonder on what scale a local currency makes sense ie: a radius of 100km, less, more?

Outside that layer any decline would not affect those inside unless its a local problem. Multiple areas can then remodel their relationships and grow or decline as needed (or possible), rather than just accept a worldwide decline in spite of local conditions.

It would seem then that we will all (worldwide) have to re-earn our currency whether in decline or not.

As a Canadian I think of this as the only means of maintaining something running. With so much of our economy tied to trade with the US, we're nowhere close to addressing local conditions without external inputs. We have a few small town examples of a local currency but nothing on a city or regional scale.

However, if a bank is nothing more than a centre for establishing a recognized and tracked business relationship, then wholly local banks (which don't exist) would be the arbitor of a local currency. Then the national currency could fry but we'd still get local jobs, food and services.

A possible burden would be in travelling and adjusting to another local currency. However since the resources are local, travelling would atune to the re-adjustment of population and liveable areas, since we will not travel as much and not to the same places as before.

If areas don't have enough serviceable density of resources then those areas can't be lived in. If people don't have enough serviceable skills then those people can't help locally unless retrained. Seems then some kind of environmental resources checklist plus a skills checklist would determine the most liveable communities that would be able to use a local currency and have the capacity to make the most crisis adjustments.

I'd venture that university-type towns in smaller communities less than 20 km away from working farmland and near waterways, would have the most likelihood for local currencies and most likely to survive Peaked Oil (my term)

Probably depends on how short you want your future life-span to be. The first step up would be single-family farmers with their own power capability; they'd do OK until they needed a vaccine or insulin or a good machine-shop or replacement parts. A small town would be slightly better; if you were lucky you'd have a local doctor and some other specialities plus some communication capabilities. My WAG would be the best would be a small to medium sized city surrounded by a farm base; have enough local power to maintain some necessary industries.

Yes, local currencies do seem like a possibility. I think a lot of what happens depends on how long we can keep electricity going, over large areas. Once it is gone, our lack of infrastructure that works without electricity will make it very difficult to travel and communicate. Many years ago, there were stage coaches. We don't really have an equivalent (but it wouldn't be too hard to set up the equivalent).

I think there will be a little trade continuing. Even in Bible times, there seemed to be trade around the Mediterranean. But I agree that most goods will have to be available locally. If it is difficult to get one essential good--say fresh water--locally, that area will have very limited population. Thus, you are right in wanting to find a place which has most raw materials it needs.

If you haven't read it, I wrote an article back in October 2007 which suggested one scenario that might occur.

In the first half of the 1800s banks were allowed to issue their own currency. The US had hundreds of different local currencies as well as the coins issued by the US government. All this unregulated currency issuing resulted in the Panic of 1837 and a very deep recession. A return to local currencies would be a big mistake.
While we like to pretend that the present financial problems are a result of the run up in energy prices I see the misguided wars we are waging in Asia as just as big if not bigger factor. Waging war has always triggered periods of inflation both during and for several years after the war's end. The huge amounts of money dedicated to war making results in the paradox of not enough money for domestic purposes during a time of too much money chasing too few goods. Just who the people are who have all this inflation driving excess money in their pockets escapes me. Everybody I know is either broke or on the edge of being broke.

I agree, i think that coining money is one of the few jobs necessary of the federal government. However, i don't think that a de facto local barter currency is out of the question. In other words, the government prints the legal tender, but that doesn't stop communities from creating a non-governmental standard that the locals consider kosher. This would be basically a formalized barter system (isn't all money?) that would allow local societies to stay afloat with in themselves, whilst allowing for a formal way to trade with other communities (legal tender). This assumes legal tender is still good, but if that isn't the case it's all barter anyways.

I think our credit monopolies (central banks) have adequately demonstrated they cannot be trusted not to cause the credit cycles associated with booms and busts. By maintaining interest rates at an artifically low level for the past few years, I think they caused the housing boom and subsequent bust. I tend find Austrian School economics makes most sense to me though, and others differ I'm sure.

I have been interested in local currencies for a while, but I've found a few things that very much complicate the process of introducing them in practice:

1) Enforcement of payment of debts - since courts only enforce debts issued in the national (legal tender) currency, people are unwilling to lend to people they don't know/trust in other currencies.

2) Tax implications - local currency systems seem to work for small transactions, hobbies and friendly (off the record) exchanges, but in order for businesses to be involved, they need to do a lot of work in calculating their tax liabilities on income (even income in the local currency). Not only this, but although they may be paid for goods or services in the local currency, they have to pay their taxes in the national currency (so they need to take some payment in the national currency in order to meet their tax obligations).

It would be good to start campaining to make the environment for alternative currencies more accomodating, but the existing credit monopolies, and their close friends (the commercial banks) would obviously not wish to see it.

Local currencies will only happen if the US government ceases to function in the way are used to it functioning. If it becomes very weak, or if state governments become dominant, one could see local currencies. Currencies pretty much have to go with the government system, for the reasons you mention.

I'm wondering about this concept of blackouts zapping electronic financials. My thought is that people with big assets would be motivated to ensure there is leccy backup to keep their electro-assets online. Whereas others with big debts would be motivated to wanting downtime and taking actions to cause it. Does anyone have any reasoning how that might play out? Thanks

I'm not sure under what conditions some credit derivatives might become activated. I wonder if any of them stipulate terms relating to lack of data availability etc? I could see this type of situation leading to a cascade of extremely complicated legal challenges though, that will take lots of time to clear. I presume during this period liquidity will greatly diminish. In thinking about this, a deflationary scenario begins to make more sense to me.

In the UK, the banking reforms due to take place in the autumn may include provisions for banks to standardise how they keep retail deposits account information. (Maybe the FDIC already does require standards from banks?) Anyway, it's so that when banks in the UK enter the special resolution regime (eg. bankrupt), the depositors can in theory be paid more quickly as the BOE/FSCS will be able to quickly interpret their data. Currently it takes months for depositors to receive compensation here, and that's just with small credit unions etc.

Having had a little more thinking time on this question -
Presumably the electronic assets (or the records thereof) are stored not in volatile ram but on hard discs with backups against disc failure. This wouldn't be a huge amount different from your bank account etc being traditionally recorded as typing on sheets of paper. In both cases we rely on the bank staff not to substitute false sheets or false files.

The main difference would be that our modern electronic records have allowed high volumes of fast transactions to take place. Which would smooth the wheels of hyperinflation, aka aggravate it for those holding cash.

It goes without saying that major banking sites, such as those processing the accounts of the supermarkets, would have major supply backup systems. And yet it also seems a safe bet that some of those backups will once in a while fail with spectacular consequences.

I am sure there would be backup systems. The question is what happens if a bank has no electricity for a year, or two years, or more. Rather quickly, it will have no (or very few) employees. If the bank made any local loans, they are likely mostly bad, because without electricity, the amount of usual business that can be done is zero. Local people might walk to the bank, to check on their accounts, but without electricity to run a computer to display what is on the back up file, it might be difficult to know what it says. FDIC people are not likely to walk to the bank to try to straighten things out.

energyblog,
I suggest that once the economy well and truly unravels, people will be totally disgusted with debt-based paper money.

Even 250 years ago the US founding fathers were aware how a fiat currency would end up; that is why the constitution specified that money would be 'gold and silver specie'.

I'll further suggest that barter is inefficient and that people will want some kind of currency that has more than local use. I recommend circulated silver coinage (so-called 'junk silver') of the US or Canada or Mexico, depending on where you live. They are of fixed weight, widely recognized, and will be welcome everywhere; of this I am certain.

I think the concept of debt based money was designed to only consider that 'growth is infinite' as a means to proxy all available resources into the economy. It never had a limit and was never designed to end. Thus only in a growth economy is a debt based money system possible with infinite resources. Well, the earth is indeed large but so have humans become and now resources turn out to not be infinite. Thus this design will have to be morphed into something else.

So what's next? I'm actually wondering about conservation of energy rather than conservation of debt as a money system and if that would work instead... That way there would be an economy in the negative slope up until it bottoms out. Then the question will be what system to use after that point?

I suppose any system would work but has to be bound by laws of diminishing returns. So any system would have a limit, and always had a limit, to available resources. Infinite growth is over, infinite decline is also not likely. In a steady-state system (apparently) all our needs are met, just not growth.

What is the shape of growth going to be if it can no longer be based on material resources?

As well, a local currency is only based on local resources and local people, so whichever money system is used could only grow up to the local resource limits, then stop. The reasons the debt based system has turned into such a fiasco is that it is no longer based on anything, not even the earth's resources.

therefore if the debt money system was based on local contraints, I wonder if that would make it more reflective of actual wealth and not fantasy wealth? Such a system would be prone to leveling off however, but that's reality for you. Living within resources isn't growth but a steady state economy, so where's the growth? Would there be any?

I think so, but in a different form.

I have to conclude then that we're moving past a resource based economy concept (since we're running out of everything) and are moving to a truely information based economy. Inside our resource based economy, this term has meant only Internet or electronic systems but I see this as a wider general issue of human education and interest. It is after all the human mind that is truely infinite, not the earth's resources. If it is to our abilities and education that our economy is based, then the resource system and monetary systems might shift successfully.

And no I'm not talking about any political -ism's, it can still be all democratic, but more on a human interest scale. Living on a human scale would still have to be rewarding. A steady-state debt based system can't supply that.

I for one won't be betting on that. The design of violins peaked about 300 years ago. Many people think that musical composition peaked over a century ago, and that the arts in general did so too. My reckoning is that most science peaked mid 20th cent since when we've had mere drivel of superstrings and supposed fusion power. The only intellectual thing that's growing much recently is decadence -- pretentiousness, superficialness, wishfulthinking, deceit.

Clearly the Fed is printing money for all it's worth, so to speak, but will it make a difference? Robert Reich compared this to offering a 10 lb. lobster to a sufferer of constipation.

But just in scale alone, the tens of billions added to M3 are insignificant compared to the $3.25 trillion destroyed in the past year just in home values. Add in all the other debt that will never be repaid, and it looks like deflation is inevitable - the wave is breaking.

Commodity inflation will surely continue as a general trend in an increasingly volatile market, but price becomes a less meaningful measure as goods are rationed by scarcity.

I don't think so. First of all the current trend is deflation - through first 3 weeks of July the commodity indexes were down over 11% (hogs being the only commodity that was up)-that trend accelerated in last week.

Remember that inflation is measure of money and credit compared to goods. The amount of credit in the derivatives market continues to dominate the amount of inflation of money supply. Remember the world derivatives market is over 600 trillion $ (or was) whereas global GDP is around 50 trillion IIRC.

Interestingly, while I was researching some safe havens during the Indymac/FDIC scare last week, I approached my local bank (who never invested in any CDOs and only have 1-2% of their assets in others products - the rest being local loans), and they DISSUADED me from depositing money in their bank. Presumably because they already have plenty of depositors (that they need to pay 2.5%) but not enough credit-worthy customers getting loans at 6-7%. At those rates, if the ratio of deposits to loans goes above 3-1, AND they continue to be unwilling to invest in external investment paper, the bank will lose money. Their assets are shrinking so they don't want to increase their liabilities....I wonder how much of this is occuring around the country.,..

Great post, Gail, thanks. Your introductory comments about systematic bias and risk are beautifully simple and spot on; I have passed them on.

NH: Remember that inflation is measure of money and credit compared to goods. The amount of credit in the derivatives market continues to dominate the amount of inflation of money supply. Remember the world derivatives market is over 600 trillion $ (or was) whereas global GDP is around 50 billion IIRC.

I apologize, Nate; I missed this conversation about the definition of inflation, and the definition of inflation is important to the issues at hand, given the disparity between real money and credit. Maybe previously one could treat money and credit as the same thing and the definition worked, when we had a functional financial system. But now derivatives are 10-15X the size of the world GDP and are leveraged 20:1 or more are being found increasingly worthless. So a lot of this credit can be categorized as losing ticket stubs similar to what you would find on the ground at the race track. So while federal reserve notes are not a whole lot better, how can you equate lost-bet-ticket-stubs with currency?

Exactly. The way I think of it, these "derivatives", in the aggregate, are mostly a bunch of I.O.U.'s arranged in a closed loop. You shouldn't add them all up and call it "money". But then, since when did economists learn to subtract? They're still only adding things into the "GDP", even losses.

Falling availability of physical resources means that, on the average, each of us will end up with less of them. In the most benign case, that'll happen via an adverse ratio of their market price to one's income. (In the worst scenario, it means world war.)

Now that adverse ratio can be arranged as high prices and not-so-high income, or low income and not-so-low prices. Those who steer the monetary system may be able to arbitrarily push in one direction or another. The effect on affordability of resourecs is the same. Alas the effect on savings and debt is not the same. If inflation works out better for TPTB, wouldn't they try and cause it? Will they succeed?

The 500 trillion dollars in notional derivative value mostly circulates off in backwaters and underground caverns removed from the regular economy. As various hedge funds go broke and get gobble up by the survivors, a lot of it will just be offset against matching obligations.
Mostly it is US dollar denominated.

If all the dollars in the world disappears tomorrow, there will still be plenty of yuan, yen, dinars and euros in the world to trade oil and grain.

The idea that prices will go down because the supply of US dollars is crashing ignores the fact that there are other currencies in the world.

It is possible for the supply of US dollars to drop by 90% - and for a dollar to still buy less, because the price a dollar fetches on international currency markets is declining at the same time.

Do you think someone in Europe is going to pay MORE for a dollar after housing has gone down 70% and the Dow just hit 4000?

When the SHTF no foreigner with any sense will want a dollar at any price. "But but but, deflationary theory says the dollar is more valuable because there are less of them!"..."Yeah, well too bad, I'm not interested in buying..."

Ten: The decline is being managed. The Chinese economy is the most dominant, and the Yuan is still tied to the US dollar (being allowed to strengthen gradually)-should the US dollar decline rapidly, the Yuan would follow it down, which means an enormous quantity of Yuan could be created. This is what the deflationists don't understand-the incredible undervaluation of the Yuan lets China increase the money supply at very high rates for the foreseeable future. This puts huge upward price pressure on every single product (including oil) that China buys.

That is interesting about banks being reluctant to take deposits. Surely they would reduce the interest rates they paid, rather than rejecting deposits?

From my understanding of structured finance, which is extremely limited, I thought there was a difference between the $600 trillion notional amount outstanding, and the amount 'at risk' (which is say 5% of this)... does what I'm saying here make any sense to anyone? maybe I've just misread/misunderstood something.

well reducing interest rates they pay is certainly an option, but one that would be unpopular with the relatively poor retired farmers (if there is such a thing) in the area.

We don't 'know' how all that 600 trillion falls to the bottom line - a great deal is interest rate swaps so yes, the amount 'at risk' is much smaller. But the point is that all of this is 'leverage'. Now we are in a period of delevering, so these positions will be unwound. I would imagine 2 years hence the global derivatives will be less than 1/2 that - perhaps dramatically less, which is gonna make it tough for banks and wall st firms to make money, (even without PO)

Yes, I see what you mean, and agree this deleveraging is going to be massive (whatever the actual losses). It would be useful to have some idea about the 'at risk' amount though, so we have a better idea whether it would be at all feasible for the government to try to inflate their way out of the mess.

It just seems to me that whatever the awful consequences of an uprecedented inflationary reaction to the deleveraging (and other losses), this, in the short-term, preserves some semblance of society (for a while) whereas deflation could end everything. Politicians seem to always take the easiest short-term decision.

What the government's reaction is is crucial to knowing how to try and preserve some wealth (in some form) through this disaster. This inflation/deflation discussion is therefore of great importance for all of us concerned about our families, friends and like minded people. Thanks for contributing.

It seems like even without all of the derivatives, there is a good chance that there is more debt that cannot be paid back than the government can inflate its way out of. (Banks that FDIC does not have funds for; Fannie and Freddie; insurance companies; pension funds; auto companies; airlines; credit card debt). Derivatives will just act to move the date forward when it cannot meet its obligations.

I've often thought that the day is not too far off when the United States will be treated like a developing country that runs its fiances like a banana republic.

Imagine if, for instance, China or Saudia Arabia agree to loan us money, but not in loans denominated in U.S. dollars.

Could crude oil become the default currency in such a scenario? Saudia Arabia will loan us 1 million barrels of oil, but with the agreement that we repay with 1 million barrels of oil plus interest. Or in other words, they give us 1 million barrels of oil now, we pay them back 1.25 million barrels in five years? The U.S. can play all the damned games it wants to internally with its currency, but they want to be repaid in something besides little green pieces of paper with pictures of U.S. presidents printed on them.

It is definitely not that far off. Currently, China exports 19% of its product to the USA. That percentage is continually declining. At a certain point there will no longer be any reason for China to subsidize the USA consumption. At that point, look out.

The U.S. economy, as a percentage of the global economy, is becoming less and less significant. If it gets whittled down far enough, perhaps we won't be as important of a customer as we are now. And like you say, at that point, watch out.

It seems to me that something that is more closely tied to barter has to be what happens in the future. Saudi Arabia will give us 1 million barrels of oil, if we provide them with an equivalent amount of wheat, for example.

I like your idea of China or Saudi Arabia lending us money, but not denominated in dollars. The only catch is that I don't think the money is terribly likely to be repaid, even in another currency, if we have all of our other obligations outstanding. If I were China or Saudi Arabia, I would want a pretty stiff interest rate as well.

If I were China, I would do exactly what the Chinese are doing now. Fighting WWIII using ones and zeroes. I have to take my hat off to the brilliance of their strategy.

The borrower is the servant of the lender. China is quite happy to lend 2 trillion or 10 trillion to the USA at rates below inflation, because they aren't thinking of short term ROI. Like post-war Japan, they are looking to be rewarded decades down the track when they reach the goal of transforming themselves into an industrial superpower.

The dollars they are lending the USA (through purchasing government bonds) did not cost China ANYTHING. It is free money. The USA sells goods to Chinese manufacturers, who get paid in dollars. The Chinese government prints up yuan and buys dollars from the Chinese manufacturers. The Chinese government then uses the dollars to buy US treasuries and agency debt. This huge "dragan hoard", now about 2 trillion, gives them political leverage over the US and gives them credibity with world currency markets - so they can print up more yuan without repercutions.

In around about way, China is able to print up US dollars themselves (at a rate equivalent to their trade surplus). They paid for their "foreign currency reserves" with fiat paper.

They will want to keep this arrangement going as long as they can, because with each year China gets stronger and the USA gets weaker. Ideally they will keep it going for another decade while Chinese industry moves up the value chain into cars, aircraft, electronics, and they build their manufacturing base up to Korean standards. Meanwhile the USA sinks further under the weight of a debt-dependancy culture.

You don't end the poker game until the sucker has lost all his money.

But in the real world it isn't "money" that matters - it is steel mills, production lines and power plants. When China has companies that can outcompete Boeing and Caterpillar, it will be time to cut our legs out from under us.

The tricky part for them will be managing the slide of the USA so that US demand destruction frees up enough oil to allow continued Chinese growth, while preserving some capacity in the US to buy Chinese imports. As they reduce their reliance on the US and rely more on exports to Europe/Arabia/BRICS and internal demand they will have more leeway to let the dollar slide.

there are several problems with this analysis, though I agree in general principle. But around the edges it gets shakey.

1)if China manages to become the industrial superpower they will need consumers, not americans in soup lines

2)if they continue up the meat/protein ladder they will have even more problems feeding their population. US agriculture system has enormous export capacity. If the world gets back to basic goods, US has way more natural resources than China. So 'dollars' are only a short term representation of this.

3)Steel in China sucks. Companies from all over world are switching orders to US steel plants. We ARE now the low cost producer of high quality steel in the world. (I have a graph on this but cannot find)

4)as mentioned in an above post, though secretly many countries might wish a dollar slide, anything precipitous would cancel out globalization and hence their own economies plunge into chaos. The only strategy is the reverse of the Washington Consensus - reverse the import substitution policies of last 30 years to be more independent of global economy. The countries that do this will have advantage

5)China may have environmental limits to growth long before the dollar collapses

The points you raise are all valid issues, but I don't think they are deal breakers.

1) Yes, China will eventually need consumers. They will be Chinese.

2) Yes, the USA will be able to export agricultural products to China, and yes, China will need to import a lot of resources. But this did not stop Japan industrialising. You can build robots while you eat rice. I expect China to invest in foreign resource companies wherever the local goverments are willing to co-operate.

3) Steel in China is mainly used in China. And it will get better as steel users move up the value chain. "Made in Japan" used to mean cheap tin toys, not a Lexus. China simply has to copy Japan, Taiwan and Korea.

4) You expect the USA to adopt a "strategy"?

5) Pollution is hideous in China, largely because they do nothing about it. Enforce the existing laws and put scrubbers on smokestacks, and they can avoid environmental limits to growth for another couple of decades.

Ten: Yes. China has a winning game so they have no interest in radical strategy change at this point. Re infrastructure, a friend of mine just came back from a long vaction touring China and he was amazed. He was especially impressed with the Shanghai Maglev train (30 km covered in 7 minutes from a standing start). We can't afford infrastructure improvements like that over here-in his opinion the subway systems were also superior to Toronto's. All this is literally from a standing start 20 years ago-the trend is very ominous for North America.

I often think that the existence of US oil refineries, and the lack of oil refineries elsewhere, has helped funnel oil to the US. Once oil is refined here, it tends to stay here. As more and more oil refineries get built elsewhere, and as world oil production declines, there will be less and less need for US refineries. If we don't refine the oil, our chance of buying it as a finished product is much lower, with our declining dollars.

In the time frame of decades I see India as bigger economic competitor than China. China lacks the rule of law and those foreigners who have invested in Chinese factories could lose the whole shebang in a decree by the Central Committee. China is a country of imitators not innovators. It is one reason for the poor quality of their steel and so many other products. Their engineers fear failure so much they stick with what worked elsewhere to the point of manufacturing large amounts of counterfeit goods. They even fear putting their own name on what they are imitating. China will always be a step behind unless there is an sudden conversion to democracy.
OTOH India inherited the rule of law from from the British. Their engineers are not afraid of taking chances. They are looking to be the world leader in thorium based reactors. With the Tata Nano they hope to become a world leader in automobile production. Bollywood already produces more major movies in a year than Hollywood threatening one of America's leading export industries. It may not be long before their aircraft industry threatens Boeing and Airbus with more energy efficient products. Mahindra and Mahindra are marketing their tractors even here in Iowa.

OTOH, there's another famous bankers' saying, to paraphrase: "If you lend someone $1 million, he better be careful. If you lend him $1 billion, you'd better be careful."

IIUC, China is a net importer of basic foodstuffs. Given its ecological disaster well underway, this situation is likely to get worse. In a culture of respect/deference, as noted above, people thinking out of the box are regarded as nails standing out who need to be pounded down. Sure, the technocratic elite there are fast becoming some of the saaviest in the world, but it is not exactly a culture of rule of law, though recent efforts suggest that is an area understood to be a serious deficiency by the Chinese themselves. Course, in China, you are working against 4,000 years of nearly total absolutist history.

India, OTOH, is the closest major power to the Persian Gulf. It has a significant tradition of modern democracy and a longer one of Rule of Law. It has a much less ecologically damaged landscape and, IIRC, the most arable land in the world.

I would not be sanguine about the potential destruction of the financial systems of the major wheat exporting countries in the world were I either of the two. If China wants to put all its eggs in Russia's basket, then I'd take all bets against that working out in their favor.

I've often thought that the day is not too far off when the United States will be treated like a developing country that runs its fiances like a banana republic.

The US already IS run like a banana republic - except that we don't produce as many goods of real value for export as does any real banana republic. Furthermore, we're not a developing country, because those still have hopes of improving themselves in the future; they actually educate their children and invest in useful things like infrastructure. The USA is a has-been country with no place to go but down.

IMO the USA is an extremely old country-you have many people making references to WW2 and the 1930s. In Europe, no one is looking to WW2 to justify future success. In Asia, no one is even looking at the 1970s. In the USA you have all this talk-Manhattan project, blah, blah, blah-nothing has been done infrastructure wise in the last 30 years-to many in the USA 1978 was like yesterday-in their opinion nothing has changed at all.

Clearly a lot worse than any post WWII recession - although perhaps we won't get there until late 2008, early 2009. Will it be worse than the depression? I don't know.

[Right now the statistics don't even show any negative growth, I think it is pretty tough to call it worse than any post WWII recession when negative growth is iffy. If the next quarter is not negative growth then there will be no official recession in 2008. Need two quarters of negative growth to get to official recession. A bad recession is not hidable. All the numbers would stink. Unemployment numbers are still fine.]

From Gail again:
I think we are headed into pretty much permanent decline (or declines, punctuated by short up periods, like our current recessions).

I expect at some point, we will be looking at banks like Citibank, Bank of America, and Wachovia failing, although probably not all this year.

[Right now it seems Gail is pointing at IndyMac bank as the big deal. When IndyMac is the 3rd largest failure and the whole thing is not up to the level of the savings and loan problem. Problems caused by mismanagement and not the result of "peak oil". It still seems the current problems are again mismanagement and not "peak oil"]

ME and Asian countries have tried to buy and in almost every case it's been blocked by the congress.

Now, I don't know about you, but to me that strikes as an odd proposition, as in the end you'll probably have to sell anyway.

Why not sell still when the price is roughly tolerable? US Banks understood this and started lying about their books since last summer and selling off to sovereign investment funds for a price that was totally inflated (and they knew it). They had to get cash infusions sooner or later, so why not get sooner, while the price still hasn't tanked?

this is one area where i think it does matter who is president, though the wrong macho closeby would be a danger too[take control & 'do it']. guys don't back down easily.

Edwards was the only candidate talking much about nukes as 'insanity'& get 'em destroyed.

what i fear ultimately is 10-15 terrible years w/o more than regional wars & w/ lots of hunger & disease & death ;& then someone with more psychopathic tendencies has control & sees major war as a ' go for broke' as an act of desperation, i. e. it can't get much worse here anyway. kinda like the homicidal/suicidal go for broke incidents.

i don't see money as the issue when it comes to major nuclear war; unless dmitry orlov is right & the technical aspects [& maintenance costs]prevent such.

If we have a financial crash, I think it may be the end of our overseas wars. We won't have the resources to fight. The new wars will be local skirmishes, perhaps over North American energy resources.

Currently the U.S. provides military defense for many countries around the world saving them the expense. If the U.S. will not have the resources to fight, then the U.S. will not have the resources to maintain overseas bases. If the U.S. pulls out, then all the socialist countries who have had subsidized militarizes will have to pay their full bill. What would that do to their economies and to the stability of Europe, Japan, Korea and Taiwan?

If the U.S. pulls out, then all the socialist countries who have had subsidized militarizes will have to pay their full bill. What would that do to their economies and to the stability of Europe, Japan, Korea and Taiwan?

Absolutely nothing as to the countries being “protected“; to us it would be a possible windfall if we chose to invest properly, not a certain outcome. Post World War II US defense budgets were one of the biggest waste of resources in the late Twentieth Century. We’ve been handed a bill of goods that all of this expenditure was necessary. All it accomplished was the deepening of suspicion and hindered any possibility at negotiation. The Cold War could have ended with agreements in the fifties, but we had to push things because we had little faith in our system winning the war of ideas, which given the present situation was probably justified. Just plain stupid. Even some conservatives argued years ago that pulling out of NATO would have been a good thing.
e

Ah, but remember that there has always been a good market for rent-a-military services, and this has always been a tried-and-true way for washed-up has-been countries with an exceptionally strong martial tradition to earn a little foreign exchange.

Has anyone ever read Snow Crash? It's a sci-fi (cyberpunk, really) classic that deals with a USA that has been hit with hyperinflation. I guess it is how i imagine the first decade or two of real oil decline, at least in the cities/suburbs. One of the things that happens in the book is that the military privatizes, which this comment made me think about. I recommend reading this, if only because it is a fun book to read.

The US $ is certainly trying to become worthless. When I was 11 years old, I could catch a bus to town for 5 cents, go to the movie for 10 cents and buy a candy bar, coke or ice cream cone for five cents. During the late 60's the motel 6 chain started with the intention of renting simple motel rooms for $6. I note that one local Motel 6 now advertises a bargain rate of $99. It is true that initially WWII helped this process along. Today there are obviously deflationary forces at work. But who knows how far will the US government take the fight against these forces?

When you were 11 years old, the average income in the US was around $4,000.
Thats what happens with economic growth. There is more money to spend on more things. People make more and prices go up. I did a cursory check for Motel 6 reservations on 3 cities in Midwest and all 3 had a price of $35.99. Average income today is over $40,000 so adjusted for inflation Motel 6 has gotten cheaper.

When I was 11 the man who hired my father was said to be making $1,000 per month. He was considered very rich. I was making 25 cents per hour mowing lawns. I started worrying about the US debt around 1944-5. We were buying 10 cent stamps to fill a book for a $25 war bond. The civics teacher at Sam Houston Junior High School in Amarillo said on more than one occasion "Don't worry about the national debt, we only owe it to ourselves" Another student and myself started a filibuster in that class. During the early 60's I would often joke "Don't worry about the national debt, we will inflate it away" I learned to type on Prodigy (P*) boards during the 90's. Deflation vs. Inflation was an active subject. One poster was writing a book on the subject. I doubt that it was ever published. I have come to the conclusion that I should probably prepare for both. There are too many black swans flying around.

--- The motel I mentioned is on the outskirts of Santa Barbara CA. I was still shocked.

Regarding IndyMac, it is a lot easier to mismanage when housing prices and defaults are working against you than when they are working for you.

The reasons the statistics don't show negative growth is because President's Council of Economic Advisors uses such a strange calculation of the GDP implicit price deflator. I calculated that for the most recent year, the change in the price deflator was equivalent to a 2.2% inflation rate. This is absurd, for anyone who lives in the real world (unless they are buying a lot of houses and used SUVs). I think the funny inflation rate is what gives us the illusion that things are going along well.

The "Funny" inflation rates gives the $1000 social security recipiant $22 more dollars to pay for heating fuel and electricity that are up $500 for the winter. The result of "Funny" inflation rate is ... "Screw em, they are about to die anyway".

Looks like GW will skate on this one and the next guy will get the blame for the really bad stuff.

I'm a doomer and I have seen nothing substantial in the last several years to change my position.

BTW: If you are into gold don't buy the big one-ounce coins. They are worth too much for a loaf of bread and the baker will not have change.

The news of layoffs/firings from the auto sector and the airlines keep rolling in, even after this figure was compiled.

And how much confidence do we have that the official unemployment rate accurately reflects the number of people who do not have jobs? The statistic does not address underemployment, in either hours worked nor in wage rate received.

It also seems that economic indicators get adjusted down the road...inflation was x% in January, and two months later refined date show it was actually x.5% or whatever. I wonder how much of that is a natural result of better data refinement over time and whether any of that is mis-reporting to try to forestall a confidence crises, make sure certain folks get elected, etc?

The savings and loan crisis of the 1980s and 1990s was the failure of 747 savings and loan associations (S&Ls) in the United States. There are currently 90-300 banks at risk.

The ultimate cost of the S&L crisis is estimated to have totaled around USD$160.1 billion, about $124.6 billion of which was directly paid for by the U.S. government -- that is, the U.S. taxpayer, either directly or through charges on their savings and loan accounts.

Between 1986 and 1991, the number of new homes constructed per year dropped from 1.8 million to 1 million, the lowest rate since World War II.

So maybe the longer, deeper recession happens in 2009-2010. But this slowdown and weakness is not it. And the longer, deeper recession requires more to go wrong and stay wrong.

Doomers that are calling what has happened so far as see recession. Are overplaying their hand and anticipating what may or may not happen. And trying to convince people that this is now already worse than in 1970's or 1980's...just makes the doomer's trying to make that case look like idiots and liars. Doomer's may still have their days of "i told you so" but not yet.

Housing has taken a strong hit. But the forecast of doom long term would be a break from what current numbers would suggest.

The dramatic drop in prices has also sidelined more buyers than in the past, and foreclosure rates are the highest they have been since recordkeeping began in 1974. All of these factors may make this downturn more protracted than usual, and credit market woes may slow the eventual rebound. Improvement spending will also come under increasing pressure because it is sensitive to both credit
availability and house price appreciation.

Nevertheless, demographic fundamentals still point to increased
housing demand over the next decade. But the excess inventory
must be worked off before the demand for new homes rebounds.
This in turn requires a return to stable-to-rising home prices, sustained job growth, and accessible credit. When that happens, and
assuming immigration remains strong, the inventory overhang will
start to thin, prices will firm even more, and average annual production, including manufactured housing, will likely head back toward 1.9 million units.

LOL! You cite a Haaarvard organization that completely missed and underestimated the housing bubble! Kind of like the "experts" in 1930 that said the downturn was nothing to worry about. By the way, guess who funds these idiots.

I think it is pretty tough to call it worse than any post WWII recession when negative growth is iffy.

The numbers may be iffy to those who see what they wish to see, but reality is anything but iffy. Look around yoau. Hell, people who've never even thought about economics have known we're in a recession.

If the next quarter is not negative growth then there will be no official recession in 2008. Need two quarters of negative growth to get to official recession. A bad recession is not hidable. All the numbers would stink. Unemployment numbers are still fine.]

All incorrect. See the link. While most think the two quarter definition is THE definition, that appears to be a only part of the definition. As for one not being "hidable," again false. Typically they don't show up till a couple quarters after the fact. It is instructive that even without two consequtive quarters of negative growth, it's being called now.

[Right now the statistics don't even show any negative growth, I think it is pretty tough to call it worse than any post WWII recession when negative growth is iffy. If the next quarter is not negative growth then there will be no official recession in 2008. Need two quarters of negative growth to get to official recession. A bad recession is not hidable. All the numbers would stink. Unemployment numbers are still fine.]

That assumes that the official stats are correct; many of us have our doubts. The 4th quarter of 2007 has already been revised down into negative territory; that anemic 0.9% for the 1st quarter of 2008 is looking pretty iffy at this point and will probably end up being revised downward into negative territory as well. Even with these revision, the inflation stats are still very likely being seriously understated; increase them just a little bit (toward reality, IMHO), and you've got GDP down deep into negative growth territory.

Unemployment is going up, and that is probably being understated, too.

I would say that is a mouthful, but I doubt if the general taxpayer will be happy with any more ideas from them. So far their ideas have put a load on their backs and taken it off the very people who have been blowing bubbles and profited by them. Just who exactly is the 'economy being fixed for?

I did a word search for :

Taxpayer, Bubble, Deflation but none came up in your article, but oil sure did and in spades.

I agree that a prime character in all this entertainment is oil. The US has gone from a great seller to a greater buyer over the last 50 years and the result is the bubbles blown by these guys G&B&P, to keep the party rolling. The current situation, while a result of changes in oil availability in the US, has expressed itself in an economic bubble/crunch . I do not think it will be fixed at least not in a manner that will ever imply-life as-it-was-before for the vaster numbers of US citizenry. The economy might be 'saved' but only for the few, the majority will be taking up the slack and some slack that will be!

I also did a word search as well for 'mortgage', lots there, but I find no mention, for instance, that home prices will have to fall to levels where they are affordable, according to the ability to pay ( generally considered a max of 3.5times earnings) before that market will have any reality. Also unless Benanke and Paulson have some way of then reblowing that bubble and selling it again to the rest of the world they will really have to cast a wide net to find another and ,when one thinks about it, a much larger bubble . (Maybe if they look down the point of a gun for it?)

I am a novice in all this and a very reluctant one at that - I would rather be on the beach in Mexico - but as I see it, the main effect will be from deflation now and if there is any serious attempt through inflation to counter that deflation we will get a worse disaster than from deflation alone. You can't fight the economy's version of mother nature just like you cant ignore what is underling all this economic turmoil - oil depletion.

I stayed away from a lot of things you are talking about because I don't necessarily see the future playing out very close to what the past has looked like. For example, you talk about home prices falling to a max of 3.5 times earnings. I am not sure that the future will look enough like today that this measure will be even relevant. If we are all growing our own food, and not doing much more, what will 3.5 times earnings mean? Will this measure be relevant, if there are no mortgages available?

I think deflation is likely. I think some of the supposed assets may more disappear than deflate, but the effect will be the same.

For example, you talk about home prices falling to a max of 3.5 times earnings. I am not sure that the future will look enough like today that this measure will be even relevant. If we are all growing our own food, and not doing much more, what will 3.5 times earnings mean? Will this measure be relevant, if there are no mortgages available?

And I covered my ass by actually saying: (generally considered a max of 3.5times earnings). Also I am growing my own food and have been practising the same since the mid 80's when I started counting all the cars on the block and imagining that that same thing and worse extended around the world and was growing, that was about the time that the Hawaii CO2 measurements had come out. It was, I thought, such a no brainer then that I too didn't see .... the future playing out very close to what the past has looked like.

I think some of the supposed assets may more disappear than deflate,

Not to draw to fine a point but in the balloon trade that is called 100% deflation, and, just if you haven't noticed, stuff has been disappearing and at a quite sprightly rate ... Kaboom!

Gail, just because I might disagree on points don't think I don't enjoy your articles - also - no one knows how the future will turn out, that is why we still go there.

Another excellent report. I recently pulled out of Fannie backed bonds for the very reasons you stated. Even though we have a bailout now, it doesn't seem nearly large enough for the scope of what could happen. Even if this is PDP, I do believe the systemic risks are greater than we can imagine because so much of the financial doings of the world are intentionally hidden or poorly understood.

With regard to pipelines, most large pipeline companies run many parallel pipes across a wide network between major cities. As flow drops, they can choose to shut down one or more pipes. Branch pipes to more remote areas such as North Dakota are another matter, and likely will experience the situations you describe. Water is used to flush the BP pipeline that crosses my property, and may well be used to maintain pressure. Building additional storage tankes at remote locations can allow for more efficient transport of product followed by days where the pipeline rests.

Economically speaking the only thing that is saving us at present is international demand for US products.

Bailing Out the Bank of China
Now that Congress has approved the bailout of housing giants Fannie Mae and Freddie Mac, those who voted "yes" are soon going to be asked an uncomfortable question: Why are you taking money from U.S. taxpayers to bail out the Bank of China and other nations' central banks?
[Henry Paulson]

It turns out the biggest supporter of the Fannie Mae and Freddie Mac bailouts has been the Chinese government. The Chinese own about half a trillion dollars in Fannie and Freddie securities and they've put the warning out...

This is rediculas linear thinking. The peak oil crowd...I mean the hard core peak oil crowd, the ones that are telling you to store water and food are typically the people in our society that have been left behind. Sort of like the nerd in class that was going to someday "be your boss" but despite his 4.0 GPA dropped out of school had three kids and a divorce before his 21st birthday.
These foolish people are hoping for the end of the world because it will be better than what they have today.

Oil is tight, this is true, but what happens when:
- American gas mileage goes up just 5 mpg (say from 22 to 27)
- The Saudi tap doesn't kick and they maintain
- The marketplace works the way if should a alternatives emerge (like alternative enregy isn't the best investing for the next 10 or more years)
- Alt energy becomes a new giant sector of our economy (+ employment + less oil use)
- Companies begin to allow employees to work from from home (some fortune 500's are already working on it (the city of Atlanta already does it)
- Massive conservation kicks in
- The China / India story dies because they are not immune to inflation and are no longer the low cost producer
- If car manufactures wake up and start building Hybrids only (and they WILL find the parts with enough $)
- At the same time many independant oils co's are pumping more and looking for more and finding more...this will at least offset declines. And if no one is growing because of the "fianacial" crisis you won't have a demand curve that looks like a hockey stick...it might be flat or downward sloping..DDDDUHHHHHHHHH

I read Simmon's book, I read Leab's book...they are smart guys, they know the business...but thier thought process is too limited and narrow in scope. It's just too linear.

Actually Simmons maintains that peak was 2005. OPEC current production numbers are faked according to him.

Notice at the bottom of the slide you reference it says "Are production figures real?". Also remember these are just powerpoint slides and you're not hearing the talk that goes along with the pretty pictures.

Actually, it's not ridiculous at all. This post might be a good place to start to see just how non-linear.

The peak oil crowd...I mean the hard core peak oil crowd, the ones that are telling you to store water and food are typically the people in our society that have been left behind

There is some truth to that. I wrote about some of the reasons why in this post on belief systems (under the heading "Relative fitness"

The marketplace works the way if should a alternatives emerge (like alternative enregy isn't the best investing for the next 10 or more years)

Many alternative energy technologies are subsidized by cheap fossil fuel infrastructure that hides very small energy gain - case in point look at the ethanol companies - why don't they make as much money as oil companies? Puny energy return, among other reasons.

Could work in theory, but NASCAR, traveling to see Gramma, Disneyland, Mall of America and many other activities that we know today will have the liquid fuels allocated away from them.

Massive conservation kicks in

Again, could work in theory, but we have become a culture who feels we are entitled to peace and prosperity with little sacrifice. Methinks the only conservation will be out of impovershment or government mandate.

Trader - there is alot to this story you are missing - I wish I could be as sanguine as you. No one knows how it will all play out, but our Achilles heel are economists and financial people that don't understand energy and ecology. Dollars don't create quality energy.

Trader - I think that I agree with most of your post. Growth is tied to energy, including leveraging it, starting with the wheel, lever, pulleys, draft animals, etc. Humans have always come up with something, although I think that right this minute, we are probably stuck on nuclear from an efficiency standpoint. But, that is only for the last 60 years, a mere pittance of time in the whole scheme of things. Computers were just invented in that time frame. So, I think that 1,000 years from now, humans will be using undreamed amounts of energy - it is just impossible at this point to even imagine what form the energy supply will be (ask somebody 1,000 years ago about the possiblility of television, cellphones, lasers, nuclear, etc). Our problem right now is that energy uses are outrunning energy innovation. Not the fact that we have hit an energy innovation brick wall. If energy innovation had outrun uses, e.g., if people who lived 1,000 years ago had all of the energy knowledge available today, they would be wondering what they could possibly do with it all. Probably we recently have had a misallocation of resources for some period of time, i.e., more people interested in inventing things that use the now formerly abundant energy, rather than focused on new sources of energy. But, a totally understandable and predictable misallocation. Many ancient societies had an abundance of food, and allocated no resources to diversify their food sources in case conditions changed. When a drought occurred that lasted 200 years, they were screwed.

So, I think that 1,000 years from now, humans will be using undreamed amounts of energy - it is just impossible at this point to even imagine what form the energy supply will be...

So you think the universe just happens to be arranged in such a way that there will always be new and better sources of energy to be tapped by an expanding human race? Seems like a tacit assumption of this sort underlies a lot of thinking: that the limiting factor is how well we innovate, as opposed to what opportunities actually exist in the real world.

The universe is already currently arranged to supply us with new and better sources of energy, we just have not quite worked out how to tap into them yet. Look up in the sky, there is a huge freaking ball of fusing hydrogen proving this.

Funny, I thought the sun was about 4.6 billion years old and was the power source we started with.

I've looked into practical fusion for some years. If you think it's guaranteed we'll find a way of doing what the sun does, in the nick of time (before massive civilizational/infrastructure collapse), in a way that's scalable, that's a fine and enviable belief. I have friends who think extraterrestrials are going to land and save us; and I'd say the same thing about their belief. Neither is physically impossible.

Still, we're left with what the real world offers, and it may not offer a perfect ladder of increasingly useful energies. You may have cause to wryly reflect on this in coming decades.

It is absolutely not guaranteed that we will find a practical way to harness all the readily available energy in our immediate vicinity in the time frame of the current crisis.

Nor is that an impossibility. A major breakthrough in alternative energy is one of many possible scenarios. Various partial and total collapse scenarios are also possible.

So there is no inevitable decline and fall.

As far as what I believe, no one can predict the occurrence of scientific breakthroughs, nor can anyone accurately judge how any of the other thousand and one variables might pan out. So anyone that "believes" they know what the future has in store with any degree of certainty is delusional.

There is only the current siltation, which IS, and many, many things that might be.

I have certain opinions on which scenarios are more or less likely of course...

We can hone in on the highest probabilities through discussions and new data and then plan accordingly. I think it is a reasonable certainty that the high quality liquid (and solid) fossil fuels are over, while population is increasing - these 2 constraints impact a large section of future scenarios..

It's also most difficult to accurately judge the probability of various events, as even with the data we have we still have nowhere near enough data. Not to mention butterfly wings flapping in China tend to effect things.

Back in the 70's and early 80's I had given better then even odds we would nuke ourselves into oblivion and would have considered the peaceful fall of the Soviet Union a very low probability event indeed.

I know the article has been circulated on the Oil Drum staff cite, and I have heard it has been discussed on Drumbeat. It would be easier to get enthusiastic about the various new proposals, if there weren't such a long developmental process between an idea and a mass produced finished product. If this discovery has been made 50 years ago, when there was plenty of oil to use in developing the new process, it would be great. Now, I wonder about whether we will have the resources to pursue it, even if it does turn out to be very useful.

It will be interesting to see if we hear any more about this in a year's time.

"no one can predict the occurrence of scientific breakthroughs, nor can anyone accurately judge how any of the other thousand and one variables might pan out. So anyone that "believes" they know what the future has in store with any degree of certainty is delusional."

No certainty, agreed. We can be confident about some things, though. One of them is that it takes a long time, about 50 years, for anything transformative to happen on a global scale.

It has taken about 50 years to change from one dominant energy source (wood) to another (coal), and the same for the next transition, coal to oil. It took one or two generations after the introduction of effective disease control before people trusted that their first two kids were going to survive to adulthood, and stopped having a few more as insurance.

The internet is often quoted as a counterexample. But in its 20 years so far, it has not affected where the bulk of people live, or how the bulk of people make a living or interact, even in the early-adopter countries. In another 30 years, this may no longer be true, even in Ukraina and Ecuador. But then it won't be a counterexample any more, since 50 years will have passed since its invention.

The delay is due to demographic and psychosocial factors. Inventions don't affect them; nor do attempts at persuasion.

So, good luck with the scientific breakthroughs, and let's hope for a real counterexample to the transition delay phenomenon.

Other people here are looking around themselves and saying, "what's out there that's been out there 20 years or so, and ready to start its 'takeoff' phase, so we can get it in place in the next 30 years?" So far, the useful answers have not looked good -- again for psychosocial reasons.

A nuclear war would take place in fifteen minutes, and I believe we would all find that a most transformative experience.

WWII took six years and most certainly transformed the world.

A Singularity for instance, could happen almost instantly.

Agree though that any positive change to our energy infrastructure is likely to take decades to permeate. In times of extremely peril, adoption bias of the salvation path tends to evaporate, I think the primary barrier would simply be the amount of time to implement on a large scale any new technology.

However there is a big difference between a global recession/depression lasting 20-50 years (with light at the end of the tunnel) and a collapse of industrialized society.

Welcome to TheOilDrum! I see you're new here. All of your 'points' are continually addressed and I doubt anyone wants to type out a complete response to all of them now. As it is, you have listed nine points that will help to alleviate the decline in oil production if they all come to pass, as just one or two won't cut it. Not expecting that to happen.

Gail, great post (btw I was just rereading your posts on nat gas & growth of unconventional - trying to understand the recent drop in gas prices - very good articles too!)

You did not mention international fallout in three key areas:
- Countries getting rid of the dollar peg
- International commodities (oil) not priced in dollars
- Countries with Sovereign Wealth Funds (now $6T) divesting USD assets

the US has had a free ride since Bretton Woods. Although there are serious systemic problems now, no one wants it to end, the world has too much invested in the status quo. But when the benefits of breaking it outweigh the costs of keeping it, it will be broken.

The recent drop in gas prices is somewhat linked to commodity funds and oil, but the larger drop in long dated contracts is due to the recent success by Chesapeake and others in the Haynesville Shale using horizontal drilling technology. Some analysts I've talked to are projecting 2.5-3 TCF by 2011 which would be 15% of our total gas production. Aubrey Mclendon of CHK is actually talking about building LNG facilities for US to EXPORT nat gas. Of course, these wells deplete at 65% first year and Barnett shale is projected to peak next year so it all might be a wash...

Okay! I get the ominous foreboding and dire straits
aspect of the financial sector of our society due to P.O....I see Leanan's post above and Gail's who post about the severity of it all. My following statement
and question might seem a smidgen strange but...I hope
someone can answer it for me.
Suppose a person was suicidal because of financial problems,further suppose they needed to educate themselves on a method to end thier life in a manner
that was most apt to #1 be successful and #2 be painless. So the person buys a book on suicide and in
a moment of genius...decides too charge the book on
their credit card, so they will "stiff this cruel world for the bill"!
The P.O. sites Ive read all had a common theme, about
paying off debt to prepare for P.O.
My question is..."If the banks all close and the goverment is broke and the fiat money is worthless...
why pay off debt?...Why not spend and party like its
1999?"
I know its probably a really stupid question but,when
Iam confused,I always ask advice from those I feel have a better grasp of and understanding then I do.

Trader_2: I think you missread my question.I actually
believe in P.O. and see the results of P.O. in the
markets right this second.I read "between the lines"
and tend to hear and see what isnt said or isnt shown
as much as what is said and what is shown. I suppose
thats why I can name 100 odd indices off the top of my
head and most Americans couldnt name 5 out of nearly 30 in their own country.Iam willing to hedge and leverage here and bet that my UK friends got my dry
sarcasim,as they tend to be keen on such levities.
Trader_2 I was using a bit of whats known as morbid
surgical suite humor to make lite of a very bad situation.
Trader_2 I dont know if you keep abreast of the markets much,but George Soros and Buffett and Pickens
arent slouches and iam guessing they see and are
reacting too whats happening...Not Jimmy Buffett...
Warren Buffet...i should have made that clear.

I can understand the reasoning. It is quite possible (likely) that we will have deflation. It will be harder to pay back debt in dollars that are worth less.

I am still not convinced that paying off debt is the "way to go". It seems to me that creditors will have virtually no way of collecting on their debts, so they will be out of luck, with so many in a similar situation. I would do what seems best for you. In most cases, that is probably leave the debt as it is.

Gail they have repealed Habeas Corpus how long is the step to debtors prison and a road gang? They had work camps in the thirties and there have been concentration camps in Canada as well as the USA. In between now and what you are thinking of could be a long and painful time, carrying a debt.

If it's going to come to a Hybridization of 'Road Gangs/Debtors Prisons/Habeas Corpus-' enforced by Private Security Corporations, then I have to wonder if those who've paid off their debt aren't the more worrying citizens, as the indebted are the rocks of this economy. (Albeit the rock is 'Brimstone') Zero-debt is the threat. Maybe it's not a good idea to draw that kind of attention.

It isn't the heartbeat of the economy that need worry , it is the deadbeats that do. Remember the Bob D. lyric "To live outside the law you must be honest."

I think that the great worrying , for those who have got out of debt (and the rare birds who never have debt), will be the fear of falling into debt again, the terms will be even more onerous in future. So as well as getting rid of debt, reduce energy dependency and learn to grow your own food or develop trading facilities. But you know that jokuhl, I think you dispute merely for pleasure's sake. If memory serves, Bob D. wrote this as well, "Let us not speak falsely now, the hour is growing late."
:)

True enough.. I was just tossing it out there as a counterpoint more than a heavy concern.. but still I think there's something safer to the authoritarian with a citizen that you have something over, as opposed to one who seems to have become 'actually independent'..

I think it depends on how you see the fallout. If you anticipate a long, slow, everlasting recession -you want to erase debt because more money will be needed for food, energy, and transportation. If you foresee a massive societal collapse, charge away -just time it up right :)

Okay, I'll be the designated tinfoil hatter:
Maybe the government won't excuse your debts, just because you and several millions of your closest friends can never pay them off. Indentured servitude, anyone?
From two years ago:http://www.democrats.com/node/7681

Stop paying your mortgage / loan while the bank can still reach out to you...

No point paying the mortgage / loan into a non-existant bank account, right? Wrong.

Thing is, here in the UK at least, the wheels turn slowly but grind very finely. That mortgage debt will exist long after ones ability to pay it has passed, even when repossessed and homeless. The remaining debt would have been bought up by a 'collection agency' incurring further costs. Even in a Post Oil world we can expect the debt collector and an accompanying goon with a gun.

Westexas is right when he says to 'get out of debt'. Never ignore your debt, don't assume that you'll get away it just because the economy is turning into coprolite

If you owe a bank say £20,000, phone up the bank and offer to pay £2000 now in full and final settlement, or the £20,000 at £50 per month, they'll probably take the £2000 and write off the rest. YMMV.

A lot of folk worry about how they are to cope, no space for a decent garden, no money for off-grid power etc. The simplest and perhaps most important thing anyone can do is to stop borrowing.

Thanks for all who replied to my question concerning
paying off debt in a pre/post P.O economy.As of now I
have no debt and the highest possible beacon score
using all 3 major credit agencies,trans,equa,experian,
I concluded before I asked my question that no debt
was a good thing......BUT, and this is a big BUT...I would shop till I drop and hire Sherpa's to carry the
bounty if I saw an eminient collapse of the American
banking system. I would fire up the ole "No Limit"
American express credit card and ride it till it
lathered in a foam.
Former banks could be re-utilised as seed storage centers...those stainless steel vaults and apocathary box walls inside would be perfect.
If people are gonna lose all their money
in their checking free savings acounts and IRA,s are all worthless at all the brokerages, I dont begrudge anyone from taking advantage of the system that took advantage of them, as long as they respect that Iam
first in line!

Gail, this is OT, but I would love to hear your comments and analysis - maybe this should be the topic for a separate post.

T Boone Pickens is saying we should switch cars to nat gas, and Joe Duarte is saying we have 100 plus years of gas in north america.

Your thoughts?
July 31, 2008

Shale Deposits To The Rescue

The U.S. has enough natural gas imbedded in its shale deposits to last 118 years and now has the technology to extract it efficiently says a study sponsored by the American Clean Skies Foundation, a group backed by the natural gas industry.
NATURAL GAS GROUP
U.S. Supplies Can Last 118 Years
by Joe Duarte, MD
Joe-Duarte.com & IntelligentForecasts.com
July 31, 2008http://www.financialsense.com/editorials/duarte/2008/0731.html

Alright already! Simmons says on that slide that January 08 is maybe the new peak (a difference from 2005 peak of +168K--what is that? Less than 1/10% of total?) if preliminary numbers don't get revised. This fits well within the fluctuating plateau of peak that has been discussed repeatedly on this site and by Simmons himself. The actual specific day that oil production peaks is UNIMPORTANT! Your posting of this quibble twice in this discussion is childish.

I need to look at the natural gas situation more closely and write another post about it. I have read the Navigant Consulting report for the American Clean Skies foundation and seen what T. Boone Pickens is saying.

I don't think there are any easy solutions. One of my concerns is that natural gas production will be affected by a shortage of oil or by a major financial collapse. This makes the American Clean Skies Report seem optimistic.

Another concern is that we currently use natural gas to provide the variable supply to keep the grid in balance, and it will be difficult to change this. This (together with a lack of investment capital) is likely to make T. Boone Pickens plan not very viable.

Having known Boone since 1945, particularly in 46 and 47 when he was one of my basketball gurus, I was quick to join http://www.pickensplan.com Though Pickens has attracted 90,000 or so members, and who knows how many onlookers, there are relatively few that understand the situation. The pickensplace forum could use more informed individuals.

Thanks for your great work on this article, Gail. Very in depth and informative. I like articles that go past the debate of Peak oil to its possible ramifications.

My opinion is that the high price of oil is due to peak oil, i.e. lack of supply to meet demand causing large rises in price, but also believe other factors have softened up the economy for higher prices of fuel to have such a damaging effect on the economy.

When Al Gore told Bush in their first debate in 2000 that his tax cuts would lead to huge deficits, Bush retorted that he was using 'Fuzzy Math', and many people laughed. Now the laugh is on us as debt rises exponentially, at all levels of government, from the federal to local and individual level.

Debt has lead to a lowering of the value of the US currency, making everything we buy more expensive, especially fuel.

Deregulation of the loan business is another major factor leading to a lending industry that constantly has to be bailed out by more US debt.

Average US personal savings percentage is less than 1%! That's the lowest of any industrialized nation.

And Peak oil production cannot keep pace with demand due to depletion of major oil reserves, coupled with expanding economies in China, India, Russia, Brazil and the Middle East.

It's a perfect storm that all points to greater debt leading to reduced financial stability in the US, and a weaker dollar versus other world currencies.

I don't even want to imagine what comes later when the gap between supply and demand widens.

Our economic system is NOT a house of cards...it's more like a Bee Hive with many structural supports...I am surpised that some of the people on this board even get out of bed each day. If its that freakin' bad why don't you just shoot yourself, it will hurt less than the pain that you are convicting yourself of.

Scientists have just started seriously translating the 'Language of the Bees', and found that they have been using the term 'House of Cards' heavily for the last couple years. They, like Peak Oilers, do still get out of bed in the morning.. but many are not coming home again that night.

Though you are not, If you WERE convinced (like me) that there was a decent chance that we were about to hit a big wall, would you lie in bed paralyzed, or would you get up and get to work on it?

Our economic system is NOT a house of cards...it's more like a Bee Hive with many structural supports...I am surpised that some of the people on this board even get out of bed each day. If its that freakin' bad why don't you just shoot yourself, it will hurt less than the pain that you are convicting yourself of.

As a beekeeper, I'm here to tell you that bad things can happen to beehives. Entire colonies can be wiped out by pathogens or parasites. A bear can find the hive and tear it apart while raiding it. Something can happen to the queen while out on a mating flight, too late for the colony to re-queen itself. The colony could fail to store up enough honey to get itself through the winter (or the beekeeper could be too greedy and take too much for himself, leaving too little for the bees), and the colony starves to death. And the list goes on and on.

Bad things can happen to economies, even the US economy. Bad things can happen to entire human societies, even to all of humankind, globally.

If I could make a humble suggestion, it sounds to me like you need to read more history. You seem to be unaware of the fact that societies have collapsed and been totally wiped off the face of the earth - not just once, but repeatedly, in many different times and places. You seem to be unaware that empires and even just so-so countries do not expand and grow more powerful forever; they eventually contract, and eventually are even wiped off the face of the map entirely. You seem to be unaware of the many times that disasters have hit societies and economies, and they have declined and deteriorated rather than continued growing. You seem to be unaware of how exceptional and unprecedented the last couple of centuries, and even the past couple of decades, have been in comparison to the rest of human history.

Perhaps if you acquainted yourself better with history, you would realize that our continued rise onwards and upwards forever into the future is by no means assured and inevitable. Bad things can happen to countries, and indeed could happen to the entire world - things that can indeed result in a period of prolonged economic decline rather than growth.

Gail's article and other pieces published here attempt to provide an early warning. For those who are wise enough to learn the lessons of history and apply them to their lives, these early warnings can be extremely valuable. Disregard them if you wish, but remember that you WERE warned.

Trader_2: Yes I do recall Bush telling Brown "Brownie
youre doing a hell of a job" and also when he said
"Rumsfeld with be with me for the duration of my administration" and when he said he would fire the person found to have leaked Plames identity and then he pardoned Scooter Libby....hahahhahaha...OUCH thats
gotta hurt!!!!!

Trader_2: Leave???...why??...a true American will stay and fight and make a better country. Americans have a history of getting rid of Georges. Maybe you werent aware that Americans...true Americans...take up
the ballot and guns when necessary and triumph.
Didnt you hate it when those Blacks got their rights?
And those pesky women got the vote?
When 12 year olds werent allowed to work 16 hours a day in coal mines and sweat shops you probably kevetched a "stronza"<----latin...look it up!
True Americans will pick the side they think is right
and not wave pom poms for the side they think will win.....wanna pic of Bush when he was a cheerleader?

Your optimism wrt the American consumers' willingness to conserve anything is unfounded, IMHO.

Tricky Dick Cheney is on record saying that the American way of life is non-negotiable. Ronnie Raygun repudiated Jimmy Carter's call to conservation by saying the same thing as the dark lord Cheney...Reagan was more eloquent in his delusion by brining his message home with the American people by invoking 'the shining city on the hill'.

I have personally talked with many, many people who refuse to understand that all of our resources are finite, especially more so when speaking about economically feasible recovery.

'Dilution is the cure for pollution' they say.

There is a pervasive attitude of "they'll have to pry my gas guzzler's steering wheel out of my cold dead hands' mentality. "I'll drive my Hummer just as much if not more even if gas is $10 a gallon!"

Many people believe that we have manifest destiny to expand our consumption as we see fit.

Trader_2 Lets see if Iam just halucinating here...
#1: Weakest dollar in history of America.
#2: Worst budget deficit in history of America
#3: Worst trade deficit in history of America
#4: Largest public debt in history of America
#5: Worst 8 year overall market performance since 1929
#6: Negative per capita savings rate not seen since
1933.
#7: Worst housing crisis in American history
Trader_2 I could go on and on but I think theres enough blood on the surgical floor already. But heres a joke you can use..."What do you call a Wallstreet trader??????.....HEY WAITER!!!!" hahahahahaha

Vaya Con Dios Trader 2. You are neither the first nor the most profound cornucopian to cast stones here. If you are right, I will still have a lower electric and heating bill than you via my solar heat and PV system, well and home garden. If you are wrong, I will survive and you won’t. Life is really simple.

Lynford: Since Ive frequented this site the past
several weeks,Ive built a garden,bought and installed
rain barrels,purchased bulk seed of every type,invested in the assortment of shovels,rakes,hoes
etc etc. Reallocated my portfolios,started a community
outreach to neighbors,purchased a wood burner,produced
a wood pile of cut and seasoned fire wood,installed
insulation to a R-value of approx 60 in cealings and walls,and Iam looking to build solar water heaters out
of stainless steel and plexiglass and to many projects to mention.
Iam seriously having FUN...and trader seemed a tad bit
angry if I might say so.

The only thing I really dread is the probable chaos time as things get worse and worse and we may have to defend our place from an element that thinks they will be able to take what they need. I would imagine that includes our cornucopian friends like Trader-2. Starvation is terrible motivator and the "ME" generation will be lost.

My guess is the financial system will be brought to its knees by consumer debt. The primary reason cash strapped consumers continue to pay on credit cards and consumer loans is they believe their credit score is more important than the benefit of walking away from the debt. When it comes down to making hard decisions about what to buy; food, shelter, and fuel trump credit scores and having the use of a credit card.

Boats, motorcycles, and second or third cars. No big deal if you have to give those back. Student loans have always been a problem. As the economy goes downhill the defaults on student loans will increase rapidly.

When people see others walking away from debt with no major consequences they will say to themselves, why not? Everyone else is doing it, why continue to pay if I don't have to? The thought that they are crashing the financial system will not be an issue. Just like energy conservation, the average consumer does not feel their part in the big picture matters.

The lowest income group will have the largest number of debt defaults, followed by the lower middle class and then middle class. I see the debt defaults eventually accelerating to the point where the entire consumer debt system collapses.

This is not a complex issue that the average consumer will have a hard time understanding and therefore unlikely to to take action on. The increasing debt defaults will be front page news day after day. All a consumer has to do is simply stop writing checks.

perhaps u are right. the small pervasive things that add up are the hardest to address in a big system like ours.

also not just lower classes. i know of professionals making this choice/consideration - to walk away re a home underwater, & one friend that tried to do this but a good salary & after the threat of coming after his wages he looked into bankruptcy & this dropped the credit debt too! he did it.

the folks i talk to re the great depression seem to communicate deep distrust re banks, $, borrowing, etc. the little things that add up.

If you look at the amount of consumer debt from the web page you reference, you will see that it seems to be flattening out. The amount of consumer debt was rising at 4% to 5% a year, but has been essentially flat since the fourth quarter of 2007. Once the amount of consumer debt actually starts to fall, watch out, because consumer spending will start dropping quickly. If lenders become more restrictive in their lending policies because of defaults, this is exactly what one would expect.

Thank you for a thoughtful and revealing analysis. Wonderful work!
I do wonder about the social implications. Clearly, defensive action will be undertaken by most people who are affected: buying less, buying cheaper, trying to save on gas.
However, the economic conjunction being what it is, pretty soon cutting down on the superfluous will not suffice: essentials, such as food and heating, will be endangered and quite often missed. A middle class that loses its perks, and has to look hunger and cold in the face, becomes a very angry middle class. A middle class that loses everything joins the poor, the homeless, the powerless, and resents this. In these circumstances, rebellions and insurgencies often take place (the French and Russian revolutions are examples of this dynamic)
I suggest that rebellion, insurgency and general mayhem within the US will become an important factor in the unraveling of this story. Probably not his year, but a tipping point could be reached very soon.
Uprisings are usually harshly dealt with by the powers that be; on the other hand, desperate people have nothing left to lose. I see rivers of blood in my crystal ball.
And I wonder what kind of society will emerge from peak oil. Will we develop smaller democratic communities, or slip back into a system of proprietors bossing it over peasants, slaves and have-nots?

I foresee the US government calling out the troops in the event of mass demonstrations, a la the 1960s--they won't back off this time like they did after Kent State out of fear of the middle class's disapproval. We'll have soldiers on every street corner (military conscription, anyone?), widespread poverty and suffering, but social stability--for a while. With McCain and the neocons in charge this scenario is extremely likely. Obama? Who knows? Maybe he'll have the social capital to get the country into WWII-type voluntary conservation, rationing, alternative energy building, transitioning to sustainability. Hey, I can dream!

The treatment of the military and the guard in the last few years makes this seem increasingly unlikely to me. The private security firms have me kind of nervous, but with the financial mess, I wonder how solvent private corps are even going to remain..

President Bush II signed a treaty with Canada to use Canadian troops in the U.S. and U.S. troops in Canada in the event of a civil emergency. I think Canadian soldiers would be more likely to fire upon American citizens and American citizens more likely to fire upon Canadian soldiers.

I don't think so. Mass demonstrations by the middle class in the street? Not likely, they are too invested in the system. Even so, there aren't enough troops to impose martial law on any widespread basis. And neocons are about to get Obama's boot up their keister.

I duuno, i never considered martial law as something that would happen in any serious capacity. The way i see it, few lifestyles are more unsustainable in peak oil than the US government's. I figure that our military will be used to scrape the remaining cocaine off the mirrors of the world so we can get one last line. Being in my 20's, conscription scares the crap outta me. Not only do i have no desire to fight in an oil war, the prospect that loosing said war would leave us lacking the resource necessary to get home is a nightmare. My hope is that the government will keep a BAU or techno-cornucopian attitude until we lack the resources to send people over seas. This seems unlikely though =/

I don't know if you read this piece I wrote back in October of last year. It was the third part in a three part series about the economic impact of peak oil, talking about one version of what might be ahead.

Very thoughtful and nicely done piece! This is the kind of stuff that is beginning to give TOD a reputation for excellence. Keep it up!

There really isn't much I can add to or subtract from what has already been said.

During these last several decades the financial system in the US has increasingly taken on a life of its own, almost completely divorced from any physical underpinnings. I think what we are seeing is the no-so-slow unravelling of that system. Whether it happens catastrophically via a series of unexpected 'discontinuities', or gradually via a dull grinding of everything into Soviet-era bleakness, is impossible to predict.

If we are lucky, all the bad stuff will be purged from the system in a realtively controlled manner, and maybe we can start doing things right this next time around. If we are unlucky, there may be cascading chaos, as one part of the system collapses after the other.

Speaking geopolitically, an attack on Iran by the US and/or Israel would very likely push everything right over the edge. Let us hope that the people who really call the shots in the US recognize that such an action would be 'bad for business' and will pull the plug.

I have just visited the Oil Drum site for the first time. I came here because in the last few days we introduced the StockResearchPortalBlog.com to the Internet. Today by 4:00 p.m. we had over 40 visits directed to our Blog by Oil Drum members. Having visited the Oil Drum and read Gail's comments and the various replies and observations related to them, I must say I am impressed by the quality of thought contributors make to their posts. I will visit Oil Drum often from here on, and we will make it the first 'linked' blog on our blog. The StockResearchPortalBlog.com regularly posts commentary on Valuation, Economic, and Stock Research issues. Aside from our Blog, contributors to the Oil Drum might consider visiting StockResearchPortal.com, a stock research website (not a blog) we introduced to the Internet in March of this year. While the website is focused on Canadian Mining and Oil & Gas company research, it includes an Economic Research tab where each month we update U.S. and Canadian (among other country) economic charts summarizing Trade Deficits, Manufacturing and Service Job gains and losses, Housing Statistics, Consumer Confidence, and so on. Access to the website currently is free. I am posting this comment in order to make Oil Drum contributors aware of our website and related Blog given the obvious interest of Oil Drum contributors in the economic drivers that I (and seemingly they) believe are important both currently and prospectively.

Gail, in my opinion your work always generates the most informative responses. Keep it up.

After all that has been said in this thread, it sounds to me like fuel rationing is inevitable, especially for commercial transportation (eg: coal, farming, fuel transport, etc). And, when this happens, I fear that our "gummint" will screw it up royally.

I appreciate all of the helpful responses I get. I try to write on topics that haven't been covered too much, even if it means a fair amount of digging for new material. The topics that are a problem for responses are ones where a huge number of people have emotional responses. If I hit one of those (for example, Offshore Drilling), I have the same problem as others with un-useful responses.

It seems like the government will want to ration fuel. I agree that it will be almost impossible to do well. I can see fuel going to the locations with the most electoral votes, or to the buyers that grease the most palms. Geographic location seems like it is going to play an increasing role--if Texas wants to keep its oil, it will be increasingly difficult to prevent this from happening.

The large banks will probably be "zombified", to borrow a term from Mish. They may never officially fail but behind the scenes the Fed will be propping them up, like dead guests at a banquet. The recent opening of the Fed's discount window to Fannie and Freddie indicate that these institutions too will become financial zombies as well. This process will continue so long as foreign investors put up with it. When they put their foot down though, look out US dollar!

If they become zombies, will they still be able to provide new debt? If not, doesn't that mean the amount of debt available will drop even more than it already has? Running off the liabilities of Fannie and Freddie would seem to cut off the possibility of new debt.

I remember in my January post about this topic, talking about the possibility of Citibank failing, and FDIC insurance covering depositors, but not necessarily guaranteeing that credit card holders will be able to get new credit from a different institution. Perhaps that is part of the issue.

I'm all dressed up with nowhere to go
Walkin' with a dead man over my shoulder

Waiting for an invitation to arrive
Goin' to a party where no one's still alive

CHORUS
I was struck by lighting
Walkin' down the street
I was hit by something last night in my sleep
It's a dead man's party
Who could ask for more
Everybody's comin', leave your body at the door
Leave your body and soul at the door . . .
(Don't run away it's only me)

All dressed up with nowhere to go
Walkin' with a dead man
Waitin' for an invitation to arrive
With a dead man . . . Dead Man . . .

Got my best suit and my tie
Shiny silver dollar on either eye
I hear the chauffeur comin' to the door
Says there's room for maybe just one more . . .

Compound interest essentially assumes infinite growth. If there is the assumption that your investments will grow at __% per year, this is predicated on the assumption that the growth we have seen in the past can continue in the future. The idea that profits will continue to grow into the future depends on infinite growth. The idea that mortgages will be paid back over a twenty or thirty year period depends on the economy continuing to grow over that period (or at least not shrinking).

But compound interest isn't infinite since the time intervals (and certainly lifespan) banks offer different rates is finite and depend on many things. Consequently they change periodically. If you would kindly point me to a bank I could invest in forever w/ no risk I'll eat my hat and probably have some (hopefully) grateful heirs. I suppose that a bank could even offer infinite accounts with compound interest, although even if they did that's no guarantee those offering them would actually believe what they're telling others (I've seen worse ways to make a buck), and if and/or when the bank goes under, regardless of what the people who ran it said in the past those who had their wealth in it won't be able to see it compound infinitely.

The assumption that profits will grow in the immediate futures is only based on projections that they will, just like the idea that mortgages will be paid back over some period depends on the assumption (based on economic regulations that vary by location) that lenders will for the most part pay them back, which may or may not be correct.

You really have to have growth to get any reasonable share of debt paid back. This may not be intuitive, but that is how it works. If there is a decline, people have less and less, and debt of all types does not get paid back.

Our monetary system is debt based. Money is created with people or businesses take out loans. Unless there is growth, there are not enough funds in the system to pay interest.

When a bank gives you a CD for five years, it is expecting that it can get sufficient income to pay you interest. If the growth doesn't continue, it is very likely not to happen. Once world oil production begins to decline, some buyers (including the US, since we can't pay for it) will have declining oil supply. Growth is almost certain to shift to decline. See some of the papers by Benjamin Ayers and Richard Warr, such as this one. I also talk about the issue in this post and this one.

We only have to have a finite amount of growth to pay back debt. Just because people take out loans and get paid interest on CDs doesn't mean the bank believes in infinite growth, just that it believes, for the most part, in growth during the duration of the loan/CD. And, like any other enterprise, they could be incorrect in their assumptions/projections over that time period.

In terms of the first link, a decline in oil production does not translate into a decline in useful work. Mostly because the majority of the work done by oil isn't of any quantifiable use. In other words, while it may only take ~15-300Wh/mile to transport an individual or two, people use on average ~2000Wh/mile. Waste is so profligate w/ most oil use that the only way we couldn't replace the amount of useful energy expended would be if we chose not to.

Finite growth is not growth.
Growth and sustainability are opposing concepts.
In life, growth is only possible when balanced by decline :
Birth is followed by growth which is followed by decline and ultimately death.
All growth must be finite - see the laws of thermodynamics.
We (meaning most of our leaders) have promised ourselves to end poverty by means of sustainable growth. But sustained growth cannot exist; you can't produce ever more potatoes on the same piece of land, pretty soon you'll have reached the maximum amount of taters your lot can produce, and soon your yield will diminish, because the growth of production has been depleting the resources needed for potato growth.
Which brings me to the conclusion that widespread affluence is going the way of the dodo. Widespread poverty will be the norm.
The real question is this : will we (the people) allow the happy few to continue slurping all of the cream and leaving us with whey?

Knowledge. It can't be taken away from you and you get a continual return on the investment.

Take courses in as many diverse subjects as you can. Woodcraft, plumbing, electrical and mechanical engineering, animal husbandry, farming....... Look at everything you own that you need and ask yourself if you have the knowledge to service and maintain it.

I would agree on knowledge. Also on things related to farming. Plant fruit trees. Get seed and equipment and learn about planting the seed. Learn about crop rotation and about other issues associated with farming.

15. There is a chance that some type of discontinuity will make financial conditions suddenly take a turn for the worse.

A third issue is the apparent inflexibility of our refined petroleum product pipeline distribution system. As I understand it, we need to have a certain amount of refined petroleum products in the pipelines to keep the pipelines filled. If we have too little, pipelines drop below the "minimum operating level," and we have trouble getting petroleum products to the ends of the pipelines.

I found this article useful in helping my understanding of the above:
( point 15 issue 3)

Gail you must deserve the award for the "most replies" at roughly 20% of all the comments. Thank you for your dedication.

On another note, in your post you said:

This situation of progressively more defaults can be expected when the world is at peak oil; it can also be expected before peak oil, if energy prices rise over an extended period because the quantity of oil available is not sufficient to meet demand at a lower price. This seems to be the position we have been in recently.

The world as a whole is talking about the price of oil these days on a regular basis and us Peakers are still using the term "peak oil" to describe the situation. In the last year or two, the term "an oil plateau" has come of age as well. All of which I assume is placing us closer to a permanent state of "oil decline". So will we still call it Peak Oil when it is obviously in decline?

Gail,
Thank you. New user here. Enjoying reading this post and will read more of your work as well as the other contributors work. Scanning comments, seems to be a pretty informed as well as mannered group. None of the "Hey Morons" type of divisive or combative comments. I look forward to sharing views and knowledge with the community here.
Regards,
Alan

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